by Ron Lambert, CFP
The Financial Planning Group Inc.
This is a question often asked of Financial Planners and it’s a difficult one to answer! Let me begin with the following comment: It is always a good idea to pay down debt, because debt is paid with AFTER TAX dollars.
Having said this however, there are certain things that should be taken into account before making this important decision.
Suppose that, through saving or perhaps an inheritance, you have accumulated $50,000. The mortgage is $50,000 and so it seems an easy decision. Pay off the mortgage. Simple! Or is it? $50,000 placed in a solid income-producing mutual fund should average about 10% per year. In other words, the $50,000 should produce about $5,000 per annum before tax.
A $50,000 mortgage with the usual amortization and about 10% interest should cost about $500 per month or $6,000 per year. Why not invest the $50,000, and have the earnings pay the mortgage? O.K., I know that amounts to only $5,000 per year. What about the other $1,000, you ask? Well, can you afford about $100 per month in order to make up the difference?
Chances are you can, and if so you still have the $50,000 when your home is paid off because you have spent only the earnings. Had you paid off the mortgage in the first place, the $50,000 would now be gone.
On the other hand, it may be prudent for you to pay off the mortgage. Suppose you had contributed regularly into an RRSP, thus ensuring a financially secure retirement. In this case, paying down the debt might make good sense.
This might also free up more money per month to allow for higher RRSP contributions.
Other considerations are your age and that of your spouse and dependents. When do you want to retire and what kind of income will you need at that time? What is your present financial situation? The considerations are many and varied and a Financial Planner will ensure that you are aware of all the options. Probably the most important of all these considerations is what do you really want to do?
The bottom line here is that there are no hard and fast rules. Each situation is unique. A Financial Planner will not make up your mind for you. The Planner will be able to give you solid advice to enable you to make an informed decision. Once your are aware of all your options, the right decision will usually be obvious.
I would be pleased to answer this, or any other question, you may have regarding your investments.
December 30th, 2006
As the population ages, more homeowners are finding themselves house-rich and cash-poor. Does the Reverse Mortgage hold an answer? Considering that the family home often represents 75% or more of one’s assets it is certainly an idea worth exploring, for the Reverse Mortgage offers a way of freeing up some of the equity in your home without your having to sell or move.
With a Reverse Mortgage - as with a traditional mortgage - the homeowner borrows money with the property as collateral. Unlike a regular mortgage, however, the debt piles up instead of being paid down month by month.
The mortgage is paid off at a later date, usually when the house is sold. Meanwhile, the borrower gets some cash while retaining ownership of the house.
The money you actually receive can be taken as a lump sum and/or a regular series of payments called an annuity. The annuity can be for a set number of years - term annuity - or for life.
Typically you can borrow up to 40% of the value of your home. The older you are the more you’ll be able to borrow. The income you receive will be a factor of your age, current interest rates, and how big an annuity you buy.
The Reverse Mortgage, then, allows you to stay in your home rather than be forced to sell or rent. It can provide for an income supplement, travel, or home care expenses. It can also serve as an estate planning tool, allowing the passing on of money to children now - perhaps allowing them to buy their own home - rather than years later as an inheritance.
But are Reverse Mortgages for everybody? Almost certainly not. All other money alternatives should be investigated first, such as selling and moving to a less expensive property as you’ll face a substantial interest penalty if you want to pay the mortgage off early. And you may find that the compounding interest on your loan has quickly eaten up a surprisingly large chunk of your home’s worth, especially if the house hasn’t increased substantially in value.
The decision may hinge on how badly you want to stay in your home. If you love it and none other will do, the Reverse Mortgage may be a solution. If another home will do, a Reverse Mortgage probably isn’t appropriate.
Consider: will your home and neighbourhood remain suitable to you as you grow older? Are you comfortable with the debt? Can you afford the potential penalties? A life or term annuity? (Life annuities are best for those 70 and older; those closer to 60 might want to consider a term annuity as your longer life expectancy will greatly reduce the size of your payments.)
A Reverse Mortgage is definitely not a solution to a short-term cash crunch. And its major drawback is that it reduces the size of the estate you’ll leave for your children.
And they can be complicated, each with advantages and disadvantages, so be sure to have any contract reviewed by an independent lawyer with experience in this type of transaction.
December 30th, 2006
