Reader Case Study - Starting Out with Huge Mortgage/Any Advice?

[H2omelon]

Hello There,

[EDIT: edited calculation based on new knowledge of rental income tax implications]

I came across this forum and started reading some of the advice that's been given to the readers here, and thought I would share my situation for some advice.

Life Situation: 26 years old, started work 3 years Consulting Engineering, single, no dependents, living in the Greater Toronto Area (now you know why there's a hefty mortgage, maybe I didn't make the best of decisions when buying the house...)

                     Monthly                Annually              Remarks
Gross Salary:   5,833                   70,000               all values in CAD

Deductions:     
FED Tax            892                    10,704               
DC Pension        392                    4,704                  7% employee contribution (6% employer match accounted for separately)
RRSP                 258                    3,096                  With the DC Pension from company, contributions are maxed out. But there is more room from
                                                                             starting contributions 2 years late. 


Rent Income    2,000                  24,000                 Renting 3 bedrooms to college students at home
Expenses
House Ins.         81                        972                   Discounted. Same company with car ins. + parent's house +car
Gas                   86                       1,032
Hydro/Water      130                     1,560         
Internet              80                      9,60                  Necessary to rent to young students glued to unlimited internet
Property Tax       323                    3,876
Maintenance       250                     3,000                Estimated. It's a 3 bedroom townhouse in Oakville

Tax on Rent        300                    3,600                 Crude estimation based on marginal tax rate. deducted mortgage and other expenses to claim 45% of expenses on income.

Adjusted
Income              5,041                   60,492

Current
Expenses
Cellphone              62                       744
Household Prod.     25                       300
Furniture               50                       600
Groceries              150                      1800
Restaurants          100                      1200
Car Ins.                 90                       1080
Gas                      100                      1200
Car Maint.             25                       300
Shopping              100                      1200
Entertainment       50                        600
Gifts/Hosting         20                        240

Total Non-Housing 
Expenses              772                      9,264

Mortgage             3,100                    37,200             750k mortgage @ 2.69% 30 yrs 1,350 principle per month (EDIT: corrected a mistake where I put 700k instead of 750k)

Asset:                 
House: Bought for 775k, with 750k mortgage with access to credit, and in my rent vs. buy calc, selling in 5 years buying & renting is exactly the same, assuming property appreciation at 2% same as inflation, and returns of 7% annually in investments. In reality since I'm not good with investing all my money, so I bought.

10 year old car gifted from mom. Worth 3,000?

Investments       
DC Pension      25,000       +392/mo.
RRSP               1,500        +258/mo.
TFSA               10,000      +290/mo.

Emer. Saving   10,000     

Savings           30,000     +1,000/mo. (holding cash to figure out where to put it and how much emergency savings I need.)     

Total Net Worth: How do I calculate this...? It's around $100,000?

So my question really is can I retire early? What can I do to retire earlier? I cannot sell the house within 5 years. (market is not the best right now, selling costs are too high, and I enjoy living here, its 15min drive from work)

Currently I am saving 56% of my gross 70k income (accounting to equity gain on the house). With my housing rent vs. buy calculations, accounting for equity gain, every month I am throwing $700 out for living in this house, vs. renting somewhere for $1000 with roommates. I bought the house because rental income or renting will only increase, while mortgage payment will decrease. It's hard to predict housing/stock markets, and worst case scenario if I have to move I will rent the unit out to 4 students, which allows me to breakeven on the house (accounting for equity).

Any advice would be greatly appreciated. If you want to see my rent vs. buy spreadsheet I can share it....maybe I made some errors? It seemed to make a lot of sense to buy at the time. In Oakville I believe houses will at least hold its value. 2 bedroom condos are reaching 400k in the vicinity.

Thank you!

[Lews Therin]

Couple of questions: What do rents cost in your area / closer to work (Because 100$ in gas a month is pretty high)
Not a similar house, but rather something your size (or just as large if you plan on renting rooms in there too)

For a 700k house to make sense as a rental, it would have to return 7k a month, and even with your renters paying 2k, that still leaves you with around a 5k portion (going in the logic of better to rent or buy)

Tax wise: Are you claiming the renters part of the mortgage interest/utilities/insurance etc etc etc? Whatever portion of the home that is being rented can be claimed in order to mitigate the increased income from rent. That includes Hydro/water/gas/insurance/property taxes/mortgage interest. Your deductions work by the amount of the home that is being used by the renters (but note that this will be a factor when you sell too)

For cellphone: Could you move over to a cheaper plan with WIND or Koodo? 62$ is high as well.

Your expenses in general are quite good!

[H2omelon]

Hello Canadian Ben,

Thank you for taking a look.

It's not easy to find vacancies in the GTA area. Back when I looked Bachelor unit would cost $1200 + $150 in utilities and car parking, and they weren't as close to work as my current house. To reduce gas spending, I could just rent a student rental master bedroom which would be $900-1000. But it means sharing with other students with no control/ability to pick who to live with. 

This house does not make sense as a income rental. The maximum rent it can get is around $3,500. Renting to 5 students (converting living room). But I would have to pay capital gains tax when selling unless I also live here. And I otherwise have no where to live. My rent vs. buy calc was heavily based on the $1,350 in equity gained. Basically I'm buying a house without paying any interest/utilities/. I treat it as forced savings. It;s very difficult to find a condo or house in the GTA area with positive income. The prices are just too high. Rent is increasing very fast also (something like $50 in the last 6 months).

Tax wise I plan to claim the mortgage interest/utilities/insurance/repairs/etc. But I am in need of an accountant ASAP to figure out how to split this cost, as you said. I am not familar with tax regulations enough to know how to optimize this yet.

Cellphone: I admit I am paying too much. I am getting a $55 plan + tax with Fido with 4 GB data. WIND has $40 with 6 GB, but I heard it's still relatively unreliable. This will be my first area to cut.

Thanks again!

[Lews Therin]

The tax code is reasonably simple to read through about the amount of deductions, I`d recommend reading on it right away, since that will bring in huge amounts of information that you will be able to keep forever (instead of out-sourcing)

For a single property owner there is not that much that applies to you, so I recommend going to the library/studying up on the subject.

Mortgage             3,100                    37,200             700k mortgage @ 2.69% 30 yrs 1,350 principle per month
So to be a bit clearer, it's 1750 in interest per month? +333 (ish) for property taxes, so that is quite reasonable.

Income: 70k
Expenses: 9,264

Total income without housing - Expenses - 16,000k taxes =  = 64% SR without housing. (and without taking into account RRSPs yet, which are helpful at 30% marginal tax rate.)
Housing: 21000 interest on mortgage) + 3k Maintenance + 1k internet + 4k property tax + 1.5k Water/hydro + 1k Gas +1k house insurance = 32500 in items that can be deducted at a set % by the amount your are renting out. (If you are renting out 30% of the home, you can deduct 30% of these bills)
- But remember, this will also be the portion of the home that can be taxed at sale if you are still using as a rental.

Cellphone: Do you need that much Data/time on the phone?

The rest, I'd cut down that 100$ shopping lower, but everything else is pretty good. To increase your earnings, you want to reduce your expenses; a great way to do that is becoming your own accountant. The gains from correctly deducting the housing expenses will outweigh almost everything else other than very impressive salary increases.

Right now (without deductions for housing) you're at 70k after taxes income-wise - 32500 housing - 9264 =  41494 which is still 60% SR according to my calculations.
(94k income, -32500 -9264 - 23500 taxes= 41494)
Both the mortgage principal, RRSP, and the pension are part of your SR, since they are savings. Adding some tax optimization, you should be able to find an easily extra 5k in tax savings. (67%)

That is with savings rate counted AFTER taxes, since that is the money you are playing with. (And aiming for with FIRE calculators)

[Lews Therin]

Accounting
Cellphone
GAS/Hydro. You can probably get this down by a significant amount. 170$ a month seems quite steep, even taking 4 people into account. After the first two have been completed, start looking at getting LEDs/lower flow showers/insulation?

For the renters, offer them a bonus of half the savings from previous bills (if they get it down to 100$, say you will use half the savings for beer/something for the house)

[Ben Kurtz]

How does gross salary of 5,185 monthly equal 70,000 annually? 5,185 * 12 = 62,220.

[H2omelon]

Good ideas Ben. Thank you.

Actually I don't even use that much data. It's past mid month, I still have 3GB remaining. I know I need more than 500MB which is what I had before, but I guess Fido talked me into paying for a lot extra.

Being my own accountant is a good advice. I tried to read the tax code but it seemed vague especially concerning renting a part of my own house. So I gave up and thought I'd get an accountant to walk me through at least the first year. But you are right, better learn it myself, not sure where to start.

Regarding the tax expense claims, I'm renting out 3 bedrooms approx. 25-45% of the total square footage. (Can be increased if I split the common areas, up to 50% at which point it looses primary resident status). That means out of 32,500 I can claim 14,625 in income deductions. My marginal tax rate is 31% over 75k, which means full tax I'd have to pay 7,200. If I deduct full amount (24,000-14,625)*31%=2,800. If I claim it over 5 years I save around 22,000. When I sell, if property did not appreciate, I benefit full 22,000. If it goes up to 820k from 775k (given current market trends I doubt it would go up more than that, if it goes up at all) I have earned 45,000 in capital gains. This would be on top of my gross income 75k from job + 20k in rent = 95k income. Capital gains tax is around 22% over 93k, paying 45% of it = 4450 in capital gains tax?

Net benefit to claim max deductions = 17,550

Monthly tax implications for rental income in 5 years= (2800+4450/5)/12 months = maximum 300 per month for 5 years. That's not too bad.

If that is the case I should just claim the expenses to completely offset the income tax from rent. When the market really does pick up I will stop claiming it.

Thank you. I will look into it more.

[H2omelon]

Hello Ben Kurtz,

70,000 is my annual salary. But I am not sure why my each pay stub is different, sometimes its 5,185, sometimes 5,384. I have no idea. I always work 80 hours per bi weekly paycheck. But I do have 3 weeks of paid vacation...

In reality maybe I should have used 5,833 in my calculations.

[Ben Kurtz]

Do you enjoy living in the house with the student roommates?

If yes, don't change a thing.

I've re-run your numbers in the background and cut them slightly differently, but even I have your personal spending at around 35% of your total salary, and your total contributions to savings at north of 40% of gross salary, with income taxes accounting for the rest.

These are excellent numbers. You'll be retired within 10 years.

And if you get married and kick out all the roommates, your spouse won't have to bring in a huge income to replace them, making it easy to move on to that stage in life (if you care to), without setting back your financial position.

Don't buy a silly new car or take up unreasonably expensive hobbies. Go outside and have fun; you've already got this figured out.

[H2omelon]

Thank you Ben Kurtz for running my numbers. :)

Good to get the reassurance that my math did not have major flaws with this insane mortgage.

Posting this also helped me realize my phone spending is proportional to my otherwise frugal ways. And I worked out I should contribute 10,000 into RRSP for index funds (I pay too much tax, should max out RRSP room to deduct tax), then contribute 12,000 of my savings into TFSA, invested in mutual funds. Then that leaves me with 18000 emergency savings for 6 months of expenses.

Thank you again for your help!

[Lews Therin]

Thank you Ben Kurtz for running my numbers. :)

Good to get the reassurance that my math did not have major flaws with this insane mortgage.

Posting this also helped me realize my phone spending is proportional to my otherwise frugal ways. And I worked out I should contribute 10,000 into RRSP for index funds (I pay too much tax, should max out RRSP room to deduct tax), then contribute 12,000 of my savings into TFSA, invested in mutual funds. Then that leaves me with 18000 emergency savings for 6 months of expenses.

Thank you again for your help!

Why mutual funds? I agree that you should fill RRSP since you have room, but why invest in TFSA mutual funds?

[H2omelon]

Hello Ben,

Currently my RRSP is holding index funds, when I top it up with 10,000 I was thinking I could stick with index funds or buy an ETF or two if my bank has the option.

The TFSA currently has the TD comfort mutual fund portfolio (They tricked when I set it up, MER is like 2%) I am holding it until the price improves a bit from last month's dip. Then selling all and changing it into the E-series. (0.5% MER). With 12,000 injection this year I am thinking of ETFs.

Then save 1300/mo on e series mutual funds (ETF trading cost too high for dollar cost averaging.)

[Cassie]

You are doing well and I would just carry on like you are:))

[Lews Therin]

Hello Ben,

Currently my RRSP is holding index funds, when I top it up with 10,000 I was thinking I could stick with index funds or buy an ETF or two if my bank has the option.

The TFSA currently has the TD comfort mutual fund portfolio (They tricked when I set it up, MER is like 2%) I am holding it until the price improves a bit from last month's dip. Then selling all and changing it into the E-series. (0.5% MER). With 12,000 injection this year I am thinking of ETFs.

Then save 1300/mo on e series mutual funds (ETF trading cost too high for dollar cost averaging.)

If you use Questrade, it's free buys for ETFs and mostly as simple as E-series. (International is a lot cheaper than E series.) - You can get MERs below .1
You can also get them to pay for switching from TD to Questrade, and add some welcome bonuses. Worth switching over when you have more than 25k in total to move over.
E series should be free to buy and sell in TD, as long as you are picking the ''E'' ETFs and are waiting the correct amount of time to sell. So no issues with buying every two weeks/per paycheck.

[H2omelon]

Hello Ben,

Many thanks for your kind advice. I researched about Quest trade, and other than the $50 dollar new account bonus, they cover transfer fees, and it is free to buy ETFs! I opened a new account over the weekend and hope to get rid of the TD mutual fund and start investing cheaply on ETFs.

Thanks!

[Dicey]

Excellent progress. When I was lucky enough to visit your fair city*, we were so impressed with the variety of lovely public transit we called it the "Planes, Trains and Automobiles" trip. Can you figure out how to use public transit to get to work?

I vehemently vote for NOT moving back to your parent's home. Buck up and learn how to stand on your own two feet, like a good mustachian. You will be so proud when you hit FIRE on your own.

Tough love alert: Include home equity in your Net Worth, NOT in your Savings Rate. You don't know what your true equity is until you sell it. You also can't spend that invisible equity on groceries. Using it to inflate your savings rate is merely creating a false pretext, IMO. If you choose to measure your savings rate by what you actually put into your investment accounts, you will have a more accurate picture, probably motivate yourself to save more, and best of sll, hit FIRE sooner.

*I was there when the Air France plane crashed on landing at YYZ. I was scheduled to leave the next day, but due to the disruption, was able to extend my trip by another lovely day.

[Lews Therin]

Tough love alert: Include home equity in your Net Worth, NOT in your Savings Rate. You don't know what your true equity is until you sell it. You also can't spend that invisible equity on groceries. Using it to inflate your savings rate is merely creating a false pretext, IMO. If you choose to measure your savings rate by what you actually put into your investment accounts, you will have a more accurate picture, probably motivate yourself to save more, and best of sll, hit FIRE sooner.

Principal is part of SR, because it is money he is not actually using to pay for things, but could take out using a HELOC, or at sale. It also makes sense for his income, since it allows him to see how much he needs to live on without taking housing into account. Though SR is a general thing, really just for mind set, and guesstimating the time before FIRE.