Toronto couple makes 5K a year. Will interest hikes hurt them?

Toronto couple makes $235K a year. Will interest hikes hurt them?

For Mei and Harold, both 27, the prospect of further interest rate hikes could mean trouble for their variable rate mortgage.

The couple have a 30-year mortgage on a home they purchased earlier this year in Etobicoke. “These recent rate hikes have really affected our ability to spend and save,” Mei explains. “With the speculation that more hikes will occur before the end of the year, we are concerned about how this will continue to affect our finances, and ability to plan for the future.”

Mei and Harold say they’re hoping to start a family in the next few years. Before they do, Mei says, the couple want to save for a big vacation and purchase a new car. They’re also trying to save for retirement. The couple wants to know more about how to juggle their savings goals with the rising cost of their home.

An occupational therapist, Mei brings in an annual salary of $80,000. Harold, meanwhile, is a software developer and makes $155,000. Generally, the pair eat their lunch at home or pack one to bring to work, opting to rarely go out to restaurants for dinner.

Weekends vary, but they tend to go shopping, visit friends or family, go hiking in the GTA and meal prep for the week ahead.

“When we see friends, we typically host a meal at our house or go to theirs, or go meet in an outdoor space,” Mei says. “We will sometimes do takeout or a restaurant meal on special occasions with friends, family, or just the two of us.”

The couple has $20,000 in a savings account, but are wondering if that is a sufficient cushion for the curveballs life might throw at them.

We asked the couple to share two weeks of their spending to see if they can hit their finance goals.

The expert: Jason Heath, managing director at Objective Financial Partners.

Mei and Harold are new homeowners hoping to have a family in a few years. They have a $20,000 emergency fund and are wondering if that is enough. There are typical personal finance rules of thumb like 3 to 6 months of income or 3 to 6 months of spending, for example. But I think there are a couple ways to answer that question.

There is something to be said about having an emergency fund that gives you peace of mind. So, in part, the answer depends on your comfort level. Sleeping well at night is priceless. On the other hand, if they put down more than a 20% down payment on their home, they could have a secured home equity line of credit at a relatively low rate of interest. For some homeowners, this is a sufficient emergency fund. And in Mei and Harold’s case, they could use their $20,000 savings for something else.

Some home equity line of credit limits will increase as you pay down your mortgage principal, so they could use their $20,000 to pay down their debt and if needed, borrow it back in the future. That way, they are paying less interest in the meantime. They are probably paying 5%+ on their debt and their savings account may only be yielding 2% or less.

Mei has a lucrative defined benefit pension plan at work, so arguably does not need to worry about saving for retirement beyond the contributions made by her and her employer. Harold has a higher income and pays about a 15% higher marginal tax rate than Mei, so any RRSP contributions by the couple should be made by him. He’s a great candidate for RRSP contributions, in fact, because he will get back about 45 cents per dollar contributed. He also has 30 or more years to compound his RRSP growth and hopefully take withdrawals in retirement at a lower tax rate.

Something for them to be mindful of as they plan to have a family in a few years is the incremental cost of children. So, it’s good to know they still have good cash flow comparing their income to their expenses and hopefully did not buy all the house they could afford. I am firmly in favour of their plan to have a few big trips the next few years before having children because it can be tough to do when your kids are young. They also seem to have their financial house in reasonably good order.

Mei and Harold cook in big batches to make sure they have leftovers for lunch. If they do not already have one, a deep freezer could be a good investment for their new home. That way, they can minimize food waste and make sure they always have a selection of leftovers on hand.

As interest rates rise, Mei and Harold could see their mortgage payments increase. Variable rate mortgages may have a trigger rate at which point payments need to increase to cover incremental interest costs. The prime rate has risen 3% already in 2022 and the Bank of Canada may not be done as they continue to try to combat inflation.

Results: They spent more. Spending in week one: $414.51. Spending in week two: $1,037.25

How they think they did: While they spent more this week, the couple feels their money went toward worthy causes. Car repairs, Mei says, were a necessary expense. Similarly, the birthday party they attended was “out of the ordinary, but a reasonable and welcome expense for spending time with friends.”

And while their trip to Costco for groceries was pricier than usual, they bought enough groceries to last about two weeks, Mei adds.

They are considering some aspects of Heath’s advice on how to prioritize their money to work for them, and note they had previously invested in a deep freezer to extend the life of some of their grocieres. “We use (it) when we stock up on meat when it is on sale.”

Take-aways: The couple says it’s “validating” to hear that they’re spending their money reasonably.

“Jason’s recommendation to explore a home equity line of credit is something we wish to explore in the future,” Mei says. At the moment, though, the couple is not eligible as their home’s equity hasn’t appreciated enough since their purchase. The level of security a HELOC offers is something the pair values, and they hope to pursue it when they’re eligible.

They’re also looking at increasing their emergency fund.

“We are both young and healthy, but the possibility of Mei going on maternity leave at some point means that we should have a bit more in the bank so we can live comfortably during this time,” Harold says.

The couple says they purchased the home they could afford at the time they bought it. Their intention, Mei explains, is to grow into their home with their future children and delay moving for a very long time — or at all.

“We recognize that this means we are paying a lot more toward our mortgage than we would have buying a smaller home or condo, which is now a scary thought with rising interest rates,” she says.

“With the last rate hike, our mortgage will be $5,350 monthly, which is over $1,500 more than when we bought the house in March and a significant hit to our ability to save. We’ll continue to save when we can, shop sales and use coupons, and explore a home equity line of credit in the future to keep up.”

Jenna Moon is a Toronto-based business reporter, focused on personal finance and affordability. Follow her on Twitter: @_jennamoon

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