Family financial makeovers

The Carnegies
James, 36; Chantal, 37; Craig, 12; Kristen, 10; Adam, 7

Income Chantal $55,000; James less than $3,000

Their financial picture
• $206,000 mortgage structured as a line of credit at 6%; they are paying the interest only, about $1,050 a month
• an unsecured line of credit (8.5%) with a balance of $8,000
• credit card balances totalling $15,000 (at 11% to 18.5%)
• whole-life insurance policies for all five family members, with premiums over $2,000 a year
• Chantal contributes $150 biweekly to a share-purchase program through her employer

The problem With only one reliable income and all those debt payments, the Carnegies have a major shortage of cash and can no longer afford sports, camps or other family activities. “I’ve even heard the kids say, ‘What do poor people do for fun?’” says Chantal.

Our expert’s advice

The Carnegies’ situation is not as bad as it might seem, says Sheila Munch, senior financial planning adviser with Assante Financial Management in Oshawa, Ont. Munch feels the family should be able to free up hundreds of dollars a month while still paying off debt if they restructure their finances:

• The Carnegies should obtain a new mortgage for $225,000 (75% of their home’s value) and consolidate their other debt. “As interest rates are at historic lows, they should lock in a fixed rate for at least a five-year term,” Munch says. Instead of covering just the interest on their loan, they should set it up so a part of each payment goes toward reducing their principal. Let’s assume they get a rate of 5.75% with a 25-year amortization (in other words, the payments will be scheduled so their debt will be completely repaid, with interest, in 25 years). Then their combined mortgage and debt repayments would shrink to a manageable $1,400 per month and save the family about $4,000 a year.

• Until the family’s debt is under control, Chantal should stop contributing to her employee share-ownership plan. “A company savings plan that is not registered — so there are no tax savings — is not the right thing to concentrate on. Once they get their mortgage paid off, they’ll have at least $1,400 a month they can save.” Chantal also has a pension through her employer that will help with retirement planning.

• They should cancel the life insurance policies on James and the three children and take the cash-surrender value of almost $9,000. “You should think of life insurance as a way to replace income,” Munch says, so it is unnecessary to insure children or a spouse who is not a breadwinner. (They can put that money toward debt repayment or into RESPs for their children’s education.) Chantal should also cancel her own whole-life policy and purchase much cheaper term insurance.

Families’ names in this story have been changed to protect privacy.

The Cavallinis
Tony, 32; Lucia, 37; Rosalba, 21 months

Income $68,000 from Tony’s full-time job and Lucia’s part-time work

Their financial picture
• manageable mortgage payments ($400 biweekly), no credit card debt, no car loan
• recently borrowed $14,000 for home renovations
• received $2,000 in baby gifts, which they would like to put toward Rosalba’s education. Lucia and Tony would both have gone further in school themselves, but their own parents saved nothing. “I’ve always regretted that,” says Lucia.
• sought the help of a financial adviser who convinced them to get a new loan for $20,000 (at 7.6% interest) so they could pay off their reno debt and invest the extra $6,000 in a rainy-day fund
• on the suggestion of their adviser, they put their $2,000 into an aggressive growth mutual fund. “He told us that RESPs aren’t as good as they seem,” Lucia says. “He said the government could change its policies in the future and make RESPs more restrictive.”

The problem The Cavallinis would like to continue building Rosalba’s education fund with the $100-a-month Universal Child Care Benefit, but they have no idea if this will provide enough to reach their goal. They are also beginning to wonder whether their adviser is steering them awry.

Our expert’s advice

Lori Bamber, a Vancouver financial author and the publisher of financialserenity.com, has two suggestions:

• The Cavallinis should open an RESP, instead of risking the baby’s gift money in an aggressive fund — which, in light of the stock market’s poor performance, is probably worth half of what it was just a year ago. (They can avoid locking in those losses by contributing that investment to an RESP and waiting for the market to improve.) “I do not share their adviser’s suspicions about RESPs,” Bamber says, and the Cavallinis will miss out on thousands of dollars from the federal government by forgoing one. The Canada Education Savings Grant (CESG) is a 20% top-up on the first $2,500 contributed to an RESP annually, and it can really add up over the years. And if the Cavallinis kick in $100 a month beginning when Rosalba is two, the money will grow to more than $46,000 by the time their daughter is 18 (assuming average returns of 6%). That should cover her tuition and books.

• It makes no sense to borrow $20,000 to pay off a $14,000 debt, so the Cavallinis should dump their emergency fund. Because they’re paying 7.6% interest on this money, it has to earn that much, and be risk-free, for them to simply break even. For the short term, Bamber says, “they would be better served by getting approved for a line of credit. That way they won’t pay any interest unless the rainy day arrives.” By using the $6,000 to pay down their home reno loan, they’ll reduce their interest payments by $456 a year, and some of that saved money can be used to build a better emergency fund inside a tax-free savings account. Launched January 1, TFSAs let Canadians invest up to $5,000 annually in GICs, a savings account, stocks or mutual funds; unlike other non-registered accounts, the earnings are tax-free.

Families’ names in this story have been changed to protect privacy.

The Randalls
Jacob, 32; Laura, 27; Emma, 6 months

Income $90,000 when both were working full-time, but Laura is currently on maternity leave and plans to work a four-day week when she returns

Their financial picture
• built a new home a year before Emma was born; the mortgage payment, including property taxes, is almost $1,900 a month
• took out a $25,000 consolidation loan requiring payments of $530 a month for another 3½ years
• recently bought a new car with a six-year loan at 8% (monthly payment $480)
• contribute $50 a month to Laura’s RRSP and $100 a month to Jacob’s

The problem “My biggest stress is not having any savings,” Laura says. “If anything were to happen, we would be pretty stuck.” She and Jacob also have very different attitudes about money. “He’s not stressed out about our financial situation at all. He’s just accepted that we’ll always have debt.” Laura also worries that things will be even tighter when she goes back to work and they will need daycare four days a week.

Our expert’s advice

“Like many people their age, they’re trying to do too much,” says Sandra Foster, a financial planner in Toronto and the author of You Can’t Take It with You. “They’ve overextended themselves by making new purchases while dragging along older debt as well.” Her suggestions:

• Shortly after consolidating $25,000 in old debts, the Randalls built an expensive house (with a monthly payment double that of their previous mortgage) and bought a brand new car. Paying 8% interest on a car loan for six years is an expensive choice, Foster says, pointing out that 6% is a more common rate today. If they can sell the car for enough money to pay off the loan, they probably should. Then they can replace it with a cheaper three- or four-year-old used vehicle.

• Foster agrees with Laura that the couple should have an emergency fund with enough to cover three months’ expenses. While families can sometimes rely on a line of credit in an emergency, the Randalls are unlikely to be able to borrow any more. With the money freed up by switching to a cheaper car and by being more frugal, the Randalls should be able to find some money to deposit into a tax-free savings account on a regular basis. “The fact that Laura and Jacob have different attitudes toward money and debt will come up time and again, and they will have to find a way to deal with their differences,” Foster says. “They should want to get rid of their debt, but also have fun too.”

• The Randalls wisely purchased mortgage life insurance, which would cover whatever remains on their home loan in the event of one partner’s death. They should also review the life insurance they get through their employers and make sure it would cover their other debt payments for several years.

Families’ names in this story have been changed to protect privacy.