July 2008 Questions & Answers

 

 


We borrowed a $50,000 interest free loan from our parents to use as a down payment for our house. They don't need to begin monthly payments for the next few years, possibly until we sell the house. We plan to sell in the next 3-5 years but will need money for our next house down payment. Our dilemma is whether to put money towards our mortgage to get it paid down, so when we sell we will have more profit after paying off our loan to our parents or should we invest that money in a GIC/mutual fund or savings account and use that towards our next down payment? We love your show and live close by in beautiful Port Hope!

Name withheld     
   

Believe it or not, this is actually an "investment" question, not a "debt repayment" question. What you really want to know is this: will your home appreciate faster than the return you can earn on a GIC, mutual fund or savings account? It's a good question.

Since the return on savings accounts haven't managed to go past about 4% in the last little while, and GICs aren't giving much more, it might not be a big jump to think your home appreciation would beat that. But mutual funds… that's a big category, and depending on what you invest in, you could see a higher return than on your home. However, since you have a short to medium term investment horizon (3-5 years), you'd want to stay with a somewhat conservative mutual fund, maybe a balanced fund.

So now you have to decide three things:

  1. Will you use the tried and true savings account/GIC option and settle for less return?
  2. Will you branch out into a mutual fund, learn how they work, and find one that'll meet your needs?
  3. How much will your house appreciate over the same period, so you can compare it with the return you might get on your investments, which, by the way, is taxable (while your home appreciation on a principal residence is not).

That's the best I can do for you. You have to do some homework and make the decision that works for you.

 

When using the affordability calculator, are we to assume that the price of the home one can afford is the mortgage amount and not the actual price of the home. I did the calculation and my home was 331000 and I put 20% down leaving a mortgage of 264800.00. If I take our combined gross income and multiply it by 2.5 I fall into the correct percentage. But if I do the same calculation I obviously do not qualify to purchase a home that is 331000. Do we use the purchase price or the mortgage amount? Thanks for your assistance.

Name withheld       
 

I find your question a smidgeon confusing and hope that I've captured the essence of it in my answer. If not, drop me another line.

I think what you're asking me is do you base your decision to buy on the actual price of the home or on the amount of mortgage you can get. Am I close?

You have to base it on the amount of mortgage you can get since the lender doesn't give two hoots how much you want to spend, just how much she's willing to lend to you.

If you find that the amount of mortgage you qualify for doesn't get you into the kind of home you want, that's where a downpayment may help. By accumulating a larger downpayment, you can increase the amount of home you can afford to buy since the amount you spend is a combination of the mortgage you qualify for, and the downpayment you've managed to save.

 

Do you recommend self-directed RRSP mortgage so you pay yourself the interest and not the bank?

Charlene        
                          
I wrote a mortgage from my self-directed RRSP and it works very well for me. But there are some things you need to be aware of. First, the return on your RRSP is limited to the mortgage interest rate you’re paying (not bad in you’re a conservative investor since you know borrowers). Second, you have to have enough RRSP assets/mortgage to make all the fees worthwhile; I’d say a minimum of $250,000. I know some people go with the $100,000 amount, but I think the fees eat too much of your return under the $250K amount.

 

My husband is a consultant and we have our own corporation. For the past two years we have been taking only dividends as income and now have enough money to pay off our house (that is money within the corporation that we have been conservatively investing with interest gained at 3.75 and some investments).  Our mortgage is up for renewal in September and we are trying to decide whether to take the money out of the company (and have to pay personal tax on it) to pay off the house, or renew our mortgage with a variable interest rate (right now we are quoted at  5 year, open mortgage at 4.05%) with the idea that if interest rates do go up THEN we take the money out of the company to pay it off.  What are your thoughts on this?  I know that all of our parents’ goals were to pay off your house as quickly as possible but I am not sure if paying off the house and sitting on a pile of equity is what is recommended these days. Thanks for any advice you may give-we love your show!

Charlene       
 

This is actually a HUGE question because the answer needs to address a whole bunch of issues.

First, the decision to pay off the mortgage or keep the retained earnings in the company is dependant  both on how old you are and what other goals you have.

If you’re using your retained earnings as a retirement savings (you don’t have RRSP contribution room if you take your income in the form of dividends), then you’re asking should you pay down your mortgage or keep your retirement assets intact.

What do you think?

I think your overall objective should be to retire with sufficient income, while ensuring you’re debt free. If you have lots of time before retirement, perhaps making extra payment against your mortgage will be good enough to get you debt-free in time. What you don’t want to do is have all your money tied up in one asset, even if that asset is your home.

 

At the end of the week of using the magic jars I have some money left over. Not much unfortunately, but where then is the best place to put that?

Name withheld       
 

Isn't it amazing that you can go on a budget and have money left over at the end of a week! Wow!
As to what to do with that money, think about this:

  1. Some of your jars are cumulative. For example, your transportation jar has "car repairs" in it, but you don't do repairs every week, so you have to accumulate the "repair" money so when you need it you'll have enough.

  2. Some jars don't give you enough in a week to do much. For example, you may have a small clothing/gift amount in that jar, and it may take several weeks of saving before you have enough to go shopping.

  3. Some expenses go up or down over time. Groceries are a good example of this. There are some weeks when my grocery bill goes way up, because I have to buy cleaning supplies, or because of a particularly large/special meal. Having some extra money around for those spikes take the pressure off the rest of my budget.

If you're sure you have money you're not going to need to spend, you could use that money to boost your emergency fund, top up your savings, pay down your debt or have a party. Let me know where and when.

 

First I would like to thank you for your wonderful and consistent advice regarding money management. I was one of those who had a "delusional" debt repayment strategy. It was definitely like trying to climb a steep high in high gear....  I've sorted out that end and with a better debt strategy and religious use of the jars my husband and I are now enjoying positive cash flow each month! Now, the last area I need to address is vehicles. We own a pair of old (1994 & 1997) gas-guzzlers. I had rationalized keeping them as they have been paid for since 2000 and 2002 respectively. Recent steep repair bills and ongoing reliability concerns are forcing me to rethink keeping them. My question is how do you go about determining reasonable repair allowances especially as the vehicle ages and, where do the inevitable car payments fall within the budget? Are they considered transportation expense or debt or both?

Lynn     
   

Great question, Lynn. I feel your pain on the gas-guzzler versus fully-paid-for-car front. When the repair bills start to mount, and the gas bill is climbing, it does may one stop and think, “hmmm.” A general rule of thumb is that if a cost of repairing your current car would be less than 15% to 25% of your car’s total Blue Book value, it’s still worth repairing. As for where that payment goes on your budget, it’s in Transportation, and your total Transportation costs – including gas, repairs, insurance -- should not exceed 15% of your family income.

That being said, for people who have lower than normal housing costs, spending a little more on transportation is okay, as long as you don’t get silly about it.


Gail, we love your show and watch it religiously in Australia.  My wife and I earn approximately $160,000 per annum. We currently have a mortgage, a few credit cards, personal loans and a car loan.  We have recently been toying with the idea of consolidating everything into a 100% home loan, with a family member providing a limited guarantee for the amount above 100% of our home loan valuation.  This amount would be approximately $60,000. We are currently paying some $5,000 per month for our monthly debt repayments.  This is not the minimum, we pay more.  With the new loan arrangement, the minimum repayment would be some $3,300.  We would continue to pay the $5,000 per month to this.  Do you think this sounds like a good idea?

Dale       
 

If you guys earn $160,000 a year, how did you manage to rack up all that debt? Or is it mostly mortgage? You haven’t broken it down, so I can’t tell, but $5,000 a month for debt repayment is a crap-load of money. I hope you’ve taken a good hard look at your spending and are cutting waaaaay back on the non-essentials.

Any steps you take to reduce your interest costs are okay with me. The fact that you don’t intend to reduce your payments so you’ll pay off the debt faster is another point in favour of this plan.

Now, if your family member had written me to ask if (s)he should be guaranteeing your loan, I would have said, “ARE YOU NUTS!”  So pray they don’t find my site.


I watch your show faithfully and always look at the people and think well we don't spend like that yet here we are with a debt load that keeps me up at night. We have good jobs ($140,000 combined yearly) but just never seem to get ahead -- between the $1400 a month child care bill and the line of credit and student loans I feel like we will never get there. The positive thing is that we currently have about $200,000+ of equity in our home.  I am wondering if you would suggest refinancing our home to wipe out the line of credit and student loans as well as our vehicle lease.  I worry about adding these things to our mortgage as the equity we have in our house feels like a safety net to me. We are on a strict budget as it is. I can tell you where every penny goes, so there is not much more room to increase debt repayment. I wonder if we should hang in there for two more years when my oldest will start school and free up some childcare $$ for debt repayment and leave the equity alone. HELP!!

Name withheld        

It’s hard to make the decision to use equity to refinance debt. I know it’s hard. That equity feels like a safety net. But you know what? With that debt hanging out there, it’s no kind of safety-net at all, because it doesn’t actually exist. That’s right. If you have $100,000 of equity and $100,000 of debt, you don’t have anything. And if your mortgage would cut points off your interest rate, making your debt repayment dollars go further in terms of paying off the principal you owe, how can that be a bad thing? I will say, this will only work if you promise you won’t go back into debt. PROMISE!

When your oldest starts school and frees up daycare money, you can apply that as an extra payment against your much-increased mortgage to pay it down faster and save on interest.


Gail, I love your show. I record it every night! I'm just wondering if there's a (monetary) threshold at which I should consider moving from using the investing services at a bank (i.e. simple money market funds, mutual funds, etc.) to using a financial advisor who will tailor a plan to my specific situation, start investing in stocks, etc. If I move to using an advisor, do you have any opinion on the different payment methods for advisors... I don't know much about it, but I guess you can pay upfront fees or pay them every time they buy/sell stocks. MY SITUATION: I'm 36 and 10 weeks (and counting) from paying off my mortgage! I've been maxing my RRSP every year. When the mortgage is gone, I'll have low 6 figures in investments and will be in a position to invest an additional $3000 per month. Thanks for any advise you can provide!

Name withheld      
  

What a diligent girl you have been and what a great position to be in. You should be very proud of yourself. Give yourself a hug.
Your question is actually quite a complicated one. There are lots of different types of advisors out there from the mutual fund seller, to the full service broker, up to the private investment counselor or investment manager. The one you choose is such a matter of personal preference and how much you want to spend in fees. Ditto the decision to go with an advisor who charges a fee upfront, versus one who charges by the trade. One is not better than the other – assuming you’ve found a good advisor. It’s a matter of what you’re most comfortable with.

Private investment management is usually available to people who have investment assets of $250,000 or more. Some houses won’t take clients with less than a million bucks. The idea behind private investment management is that once you have enough money to diversify your portfolio, you don’t need to use investments like mutual funds, since your investment counselor can build you a portfolio that exactly meets your needs for safety, income and growth, in any combination you choose.

I will tell you that regardless of whom you choose to manage your money, you should be aware of the fees involved. Whatever fees you pay will reduce the amount of capital working for you. A management expense ratio (MER) of 2% may seem small, but if your annual return is 8% before fees, you’ll have lost one quarter of your return to fees. Yuck! 

So your next question is probably, where do I go? Good question. And I can’t answer it for you. You have to do the research, ask the questions, figure out who you’ll be comfortable with. You can start by asking your financial institution if they have a wealth management arm, and see if you like anybody there. Failing that, get out your walking shoes girl. It’s time to do some serious shopping.


Love your show, but especially your advice.  IT WORKS! My question is this: You say that we should pay the minimum on all credit cards and focus on paying off the largest one.  When that is done, move to the next largest. Should we be focusing on the largest AMOUNT or the largest INTEREST RATE?

Name withheld 

Focus on the highest interest rate.