Couple must regroup to shed $ 1.5M in debt

Mid- life couple’s rental properties produce scant income Sell rentals units, invest to get return adequate to finance retirement Growing cash cushion for emergencies, education, retirement

Acouple we’ ll call Tiff and Sandy turned their longtime friendship into a union when they bought a house in British Columbia and combined their fortunes in 2008. The relationship came with a lot of baggage, however. Each had a house with a mortgage. Then they bought a new residence and used a line of credit to add a rental apartment to the new house. Their $ 1.5- million of debt is 12 times their gross employment income.

Revenue from the income properties barely covers their total costs — mortgage and line- of- credit interest, taxes, utilities, insurance and maintenance. Add in falling prices in the sliding B. C. housing market and the couple is subsidizing losing investments.

They save only $ 100 a month for RRSPs and $ 25 a month in an RESP for Sandy’s nine- year- old child from a former marriage. At mid- life, the couple, each of whom works for a large publishing company, has just $ 31,000 of RRSPs and almost no cash. The good news is that Tiff, 49, and Sandy, 45, have two decades to restructure their investments and finance their retirements.

Family Finance asked Adrian Mastracci, a portfolio manager and financial planner at KCM Wealth Management Inc. in Vancouver, to work with the couple. He is candid in describing the issues.

“The couple’s problems are far too much debt, especially for properties that are poor investments, and an excessive concentration in real estate, for each unit is within just blocks of the others,” he says. “This is a situation in which the total portfolio has to be rebuilt, RRSPs boosted and retirement income planned.”

Looking ahead

They started with 25% conventional down payments, but now find themselves with about 10% equity in the rental units as a result of falling property prices and debt- financed buyouts of former partners. Their return after paying all interest costs, utilities, insurance and taxes is negligible. Unless they can raise rents drastically or realize future capital gains, the investments are flops.

A financial crisis triggered, perhaps, by unemployment, illness or accident would require them to add debt, for they have just $ 2,000 in cash. If interest rates rise by 1% or 2%, they would be forced to refinance, but they already have 30- year amortizations. To pay more interest, they would have to face deregistration of some or all of their $ 31,000 of RRSPs, heavy taxes on payouts or, in the worst case, bankruptcy.

Real estate has produced substantial gains for homeowners in parts of B. C., but the boom is waning. When interest rates rise, prices could fall further, for most people buy what they can afford and, with higher borrowing costs, they will afford less.

a workout pLan

If all income properties are sold, they would realize $ 1,052,000 less selling costs of perhaps 5% for net cash of $ 999,400. They could use that money to retire mortgage debts totalling $ 911,000 with the balance, $ 88,400, going towards paying down $ 46,000 of credit card debt and $ 74,000 in lines of credit.

Sale of the income properties would liberate $ 3,842 a month of mortgage-service charges and $ 197 a month of line- of- credit payments for total debt relief of $ 48,468 a year. Without rental income there could be genuine savings of $ 30,000 a year, Mr. Mastracci estimates.

Some of the cash flow liberated from paying down mortgage debt and other costs for the three properties can add to the $ 3,000 RESP. They also have $ 177,000 of unused RRSP room and $ 51,000 of combined TFSA room.

If the RESP gets $ 2,500 a year, it will qualify for the Canada Education Savings Grant of the lesser of 20% of contributions or $ 500 a year. At 3% over the rate of inflation, the fund would have $ 35,000 when the child is 18.

If the couple puts $ 16,000 a year into RRSPs, when Tiff is 65 in 16 years, they would have about $ 380,000 in 2013 dollars based on a 3% return after inflation.

If Tiff and Sandy have used the $ 11,000 of the remaining balance of annual savings for TFSAs, in 16 years with savings of $ 5,500 a person per year at 3% over the rate of inflation, they would have $ 228,000. That would generate $ 6,840 a year on the same basis.

Their RRSPs, paying 3% over inflation, would generate $ 11,400 a year.

Their retirement income would therefore consist of employment pensions that will pay them a combined $ 31,000 a year, Old Age Security beginning when each is 67 of $ 6,553 per person, Canada Pension Plan benefits based on work history of $ 9,720 a person per year, total RRIF income of $ 11,400 a year and total TFSA income of $ 6,786 a year, all in 2013 dollars. The sum, $ 81,732, would leave them with $ 5,448 a month after paying 20% average income tax. That would be close to their present spending with debt- service charges on rentals, utilities and credit cards eliminated.

“By selling their non- performing income properties, Tiff and Sandy can raise their standard of living, create savings, add to RESP and other registered savings, and increase their financial security,” Mr. Mastracci says. “We have shown the outline of what can be done. Now it is up to them to do it.”