Family file: newlyweds

Family file case study: Tim and Wendy get married

Financial Post November 07, 2008

Tim and Wendy McKeon just got married. They both turn 30 next year and hope to end their 20s triumphantly with the purchase of their first home. They’ve never owned a property, but they’re tired of paying nearly $20,000 a year in rent. They want to stay in the city – they both work in Toronto. Tim is a software manager and Wendy is a grade-school teacher.

Together, they pull in about $164,000 a year, including Tim’s yearly bonus. “We’re not sure how much we can afford to spend on a house,” Tim says, “but we don’t want to wait to buy one.”

The catch? After dropping $50,000 of their own dough on the wedding (complete with Hawaii honeymoon), they find themselves with no savings and no solid plan for the future. Admittedly, they’ve only been married a few weeks, but the couple are wondering if they can drum up enough cash for a downpayment by the end of next year.

Tim and Wendy have never been much good at saving money. “We’re definitely not frugal in any way,” Wendy laughs. “Lately, we’ve gotten more control of our spending, but I think we spend too much on entertainment and things like that.”

After the wedding devastated their savings account – “so worth it,” the couple says – they found themselves needing car maintenance, then snow tires and so on. “We just kept depleting our savings by dipping into it for emergencies,” Wendy says. “We want to start a separate fund, but we’re not sure how much we should keep in it. How much should we set aside each month for emergencies and big purchases?”

Tim admits to being the more unruly spender, which he has tried to get under control by creating budgets and making an effort to spend within them. Each month, they spend $500 on groceries, $200 for cable and cellphones and nearly $600 on their car, car insurance and public transit pass. Another $100 goes to their maid, and $250 to repay a loan from Tim’s father, incurred during the lean days of his early 20s.

When it comes to personal purchases, Tim and Wendy admit they each drop about $160 a week on such things as take-out food, entertainment and going out for drinks. On top of that, they each allocate $300 a month for more expensive perks such as massages and clothing. “Clothes are my guilty pleasure,” Wendy admits.

When asked about the future, the Mckeons say they don’t have much of a retirement plan. Tim has about $10,000 in RSPs, and each month he deposits $400 into the plan, which his company tops off with another $200. Wendy has a pension, but no RSP, and is worried that this may make her retirement goal of 56 difficult to achieve. Tim doesn’t know when he’ll retire. “By age 60 I want to at least be cutting back on the amount of hours I need to put in, and hope to live off a smaller salary.”

They are just about finished paying off a line of credit, and plan to be debt-free and ready to start their real estate search in earnest by December. They’ve considered finding a place with a rental unit, to share the cost of mortgage payments. If they can get their spending on track and buy a home, they’ll be free to think about the next step: filling it with children.

David Salloum, CFP, RBC Dominion Securities Inc.

The first thing Tim and Wendy need to do is to prioritize their wish list, which includes a home, emergency fund and later, children. I agree they are far from frugal and suggest they look at cutting back on expenses like eating out, buying clothes and going out for drinks – all fun stuff, but at $2,860/month, will only move them further from their goals. A budget will help them determine a limit, so smart decisions can be made about what to do with any extra income.

The Toronto area is a buyers market thanks to the current slowdown in home sales. This may last into 2009 and provide an advantage for them, but after that, who knows? The McKeon’s could withdraw RRSP funds under the Home Buyer’s Plan, which provides a maximum of $20,000 each towards the down payment on a home. They should keep in mind that this is essentially an interest-free loan and has to be paid back over 15 years.

The minimum the McKeon’s can pay is 5% down (for a $500,000 home that’s $25,000). Assuming a 6% interest rate, the McKeon’s would be looking at monthly mortgage payments of about $3,100. They also need to consider other house costs like mortgage insurance, property taxes, insurance, etc. They definitely need to save more, either by cutting costs, increasing their monthly savings or saving for a longer period.

If a house is the first priority, they may want a line of credit for emergencies until they are able to build an emergency fund, which should cover at least three months’ expenses, and hold off on any vacations or major purchases until after the home is bought.

They’re also considering children in a few years. Basically, everything hinges on whether the McKeons can start saving, and not spending all that extra money on massages, drinks and clothes.

What the experts say

Michael A. Thorne, CFP, CLU, CHFC, Thorne Financial Planning

Wendy and Tim have lots of opportunities, but without a good map, it’s anybody’s guess where they will end up. They need to know how much they want to spend, on what, when. It can be as simple as keeping an envelope with the week’s cash for groceries and entertainment. Keeping track of spending is critical to success.

As potential home buyers, the McKeons should feel no pressure to buy immediately. The economic crisis is not likely to dissappear for some time, giving them time to accumulate an emergency fund and a reasonable down payment. The McKeons feel they can save $1,100/month. They should consider using a high-interest account like the Tax Free Savings Account, available in January, 2009. They can also do things like eat more home-cooked meals to bring their weekly budget to $200 each, and reduce clothing costs from $600 to $400 per month. Such relatively small belt-tightening changes will allow them to increase their monthly savings to nearly $2,250 a month. If they can do this, they can save the minimum 5% house downpayment in about 10 to 12 months. At 6% interest, and a 25-year amortization period, Wendy and Tim would pay about $2,735 a month on a $427,500 mortgage.

One of the dangers of these types of projections is the possibility that interest rates will rise subtantially in a short time. They should also consider the financial cost of having children. If the interest rate rose to 8%, mortgage payments would rise: Can Wendy and Tim afford an extra $500 a month and one parent is only working part-time? Not likely.

Although retirement is likely fairly low on their priority list at this stage of their life, relatively small contributions now will have relatively large consequences at retirement age. As long as Tim’s current income tax rate is substantially higher than Wendy’s, they should put their contributions in his RRSP.

Jason Maher, Financial Planner, BMO Bank of Montreal, Barrie, Ont.

Wendy and Tim say their first priority is buying a home and would like to buy one in a year’s time. However, to put at least 5% down, plus closing costs, they would need to save $1,875 a month over the next year. While their incomes would allow for that aggressive savings goal, it may be unrealistic as it would mean making dramatic changes to how they’re living.

Instead, they may want to consider a more balanced approach to achieving their savings goal and revise their timeline for a home purchase to two years.

That still means tucking away $900 a month, which will require major adjustments to their spending patterns. Excluding Tim’s bonus, the couple currently spends more than one-quarter of their take-home pay on entertainment, clothing and eating out with friends. One key to saving for the down payment is having a set amount deducted from their paycheques into an RRSP account. Thanks to the First Time Home Buyers Plan, they can withdraw up to $20,000 tax free from their RRSP to purchase their home.

An emergency fund is essential to easing anxieties over money matters. Unexpected events like losing a job or an illness can wreak havoc on your financial plan. Tim and Wendy should work toward building an emergency fund that would house enough savings for three months’ worth of fixed expenses – in their current situation that would mean $15,000. They should set aside $250 a month that would allow them to reach $15,000 within five years without sacrificing their new home purchase or retirement savings.

Just because they’re young, Wendy and Tim should not put off planning for retirement. In fact, they should use the luxury of time to their advantage. Their goals of retiring at 56 and 60 are achievable if they start saving for their retirement now. As a teacher, Wendy will likely have a healthy pension, but she should also set up an RRSP and make small, steady payments – even $200 a month would help. These small amounts will let them benefit from dollar cost averaging. This means that as they regularly invest they will purchase mutual funds at different rates, depending on the daily value. As the markets fluctuate, that daily value will change. When the value is low they will purchase more units and when the value is high they will purchase less. Over the length of their investment they will end up getting better value for their money.

They should consider allocating Tim’s annual bonus to his RRSP. This would provide him with a substantial tax refund, which could be used toward their down payment or emergency fund.

Tim and Wendy are in the enviable position of having little debt, and a bright future together. Three key strategies will help them achieve their goals: develop some smart spending habits, set up automatic payments to increase their savings and most importantly, continue to take advantage of financial planning advice that will help them to stay on track.

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