“Jean and Gary plan to marry in April, pay off Gary’s student debt and save up for a month-long backpacking trip to South America. Easily done.
Their longer-term aspirations will take more effort. Mind you, at 28, their dreams look possible – a home, a family, a “robust” investment portfolio. Jean will graduate this summer and hopes to get a job, perhaps with a municipal government, paying in the $60,000 range. In the meantime, she gets about $2,100 a month working as a research assistant. Gary earns about $60,000 working for a regional transportation authority.
Already, they’re thinking about their financial future.
“We think we are generally pretty wise with our money but are keen to learn about financial planning and investing,” Gary writes in an e-mail. Once Jean starts work, they intend to begin saving to buy a house in Vancouver in about five years.
“We are unsure if we can afford to buy a place and wonder if we should continue to rent for the longer term,” Gary adds. Their rent in Vancouver is $1,600 a month. They figure a house that will meet their needs will cost at least $800,000 in that market. Alternatively, to get a foot in the real estate market, they are mulling buying a rental property in Gary’s hometown in small-town Ontario.
Once Jean starts working at a salary of $60,000 a year, the couple’s cash flow will improve substantially, Nancy Woods (investment adviser and associate portfolio manager with RBC Dominion Securities Inc.) says. …
Once the student loan is paid off in 2014, the couple will have a surplus of about $13,065 a year or about $1,090 a month if they keep their expenses in check. That’s on top of their registered retirement savings plan and tax-free savings account contributions. This money can go toward saving for a down payment.
With time and compounding at 5 per cent a year, they could conceivably save more than $160,000 by 2017, the planners calculate. They could withdraw $35,000 from their RRSPs under the federal Home Buyers Plan, $74,410 from their TFSAs and $52,000 from non-registered savings, for a total of $161,410.
Even so, they may want to rethink that $800,000 price tag on a home. If they put $160,000 down on an $800,000 house, they’d be left with a $640,000 mortgage. Amortized over 25 years with an interest rate of 5 per cent, the loan would cost $3,700 a month in principal and interest. If, instead, they bought a $600,000 house with the same down payment, their monthly mortgage payments would be $2,560. …
For their first home, Jean and Gary may have to start with something very small and out of their current area, the planner says. “A home is their best non-taxable investment, and besides, they have to live somewhere.”
– from ‘Building a foundation for long-term dreams’, Globe and Mail, 24 Feb 2012
Hey, with a household income of $120K, if they save diligently, they could afford to buy a basement suite in South East Vancouver, in 2017, for $600K. But, wait!… at the assumed annual property price appreciation of 7% to 10%, in 2017 that basement suite will cost them anything between $840K and $966K… The price will appreciate much faster than they can save! So, wouldn’t it be better for them to go all-out right now, get together as big a downpayment as possible (cue boomer-parents bearing HELOC derived gifts), borrow as much as they possibly can, and get into the market ASAP? Otherwise, they’ll be priced out, right? No chance of ever owning anything!
Okay, ‘/sarcasm off'; but you get the picture.
This is precisely the kind of perverse thinking that has gotten buyers of almost every stripe to overextend themselves, as early as possible, into as much RE as possible, in order to catch the Vancouver RE train. All premised on future price rises.
The couple in this story will possibly be okay. Our hunch is that a fair number like them won’t over-extend into anything just yet, largely because what they can get now at the top end of their budget is barely what they’d define as a ‘home’. Then the crash will bail them out.
Sometimes it pays to be so late to the party that it’s over when you get there.