Jane’s sister admits to reading this blog, and suggested Sis write in for some Dr. Garth advice. This is never a good idea, but let’s proceed.
“I live in a nice townhouse in a desirable neighbourhood in North York. I bought it for 360,000 and am currently carrying a mortgage of 305,000. I think it’s worth maybe $420,000 now. I make a decent income (88,000) but I’m a single mom so money is pretty tight, and I have no other assets. I have grown increasingly tired of my inability to stay out of debt (currently approx. 24,000) and am looking at solutions. I’m trying to decide what to do and I’m looking at two different options.
“1. Sell now and get out of debt and go into the rental market (or maybe purchase a less expensive condo) or 2. Rent out my townhouse (I have someone interested) for an amount that covers my mortgage, property tax, maintenance fees and rent something cheaper and continue to pay off my debt. I’d appreciate any advice you have for me. I’m sure there are more options than I have listed such as refinancing but I am reluctant to do this again.”
Sis pays $1,600 a month in financing, plus condo fees, insurance and property taxes, which is a few hundred dollars more than she’d fork over in rent in that location. But that’s not the main issue. The woman spends more than she earns. Her only asset is her house equity, and her net worth is about ninety grand, none of it in liquid assets.
Sis clears $66,600 after tax, or $5,500 a month. The house costs about $2,200, or four-tenths of her take-home. Daycare in Toronto runs around $1,200, which leaves $500 a week for food, clothes, car and all else, including interest in $24,000 in debt. Obviously she cannot colour inside the lines, so something has to give.
Rent the townhouse out to cover its carrying costs? Bad choice. That achieves nothing, especially if real estate values flatline or decline as mortgages rates unavoidably increase. Tenants can do damage or skip on the rent. Even a month or two of vacancy would create a personal crisis. And the condo corp could always come knocking with a special assessment.
The best choice is to sell, unlock the tax-free equity, pay off the debt and rent. This will reduce monthly costs by a few hundred dollars and leave her $90,000. If that all went into an RRSP (assuming she has the accumulated room), then the tax refund of almost $30,000 could fill a TFSA. Now Sis has a net worth 30% higher, no mortgage to renew at swollen rates down the road, and $120,000 she can start growing. If she gets 7% on a balanced and diversified portfolio (consistent with the last decade, which included the crash) then she has about $250,000 in ten years – money for her and her child.
Of course, she must have the discipline and knowledge to unlock the equity, trash debt, invest properly and not piss away the money. And here’s where most people fail. It’s the strongest argument to be made for owning real estate. Buying property gives the chance to employ leverage, as Sis did, doing it with just 5% down. So any windfall gains in its value magnify profits. (Just as minor drops in value can instantly erase them.) Facing a monthly mortgage payment also forces people to save, since a portion of each one is debt. So long as the property does not lose value, you’re putting away value which can be cashed in later. Finally, gains are non-taxable on your principal residence, but all costs must be paid in after-tax dollars.
As for investing, most Canadians are useless. They know what [email protected] tells them, and little else. They buy houses because GICs pay nothing and stocks are dangerous. Banks (naturally) encourage debt. Besides, her parents were so proud when the mortgage was signed. It’s a self-perpetuating familial cycle of willful ignorance. But in years when money’s cheap and greater fools abound, it works.
As you know, over 50% of all TFSA money is in bank accounts or equivalents, earning less than 2%. The savings rate is 80% less than it was a generation ago. Household debt is at an historic level and incomes are flat. And for Sis, this week’s Ontario budget just increased taxes. Already she can’t live on $88,000 a year, which is above the average. So obviously all is not well with the middle class.
Real estate bulls will say her property profit saved her. That’s correct. But smart people harvest gains and rebalance their lives, as they do with their investment accounts. There is absolutely no assurance housing will continue to appreciate, while there’s irrefutable proof Sis can’t live on what she makes.
The moral of this small tale is simple. Think.