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30-Something Hates Debt, Worries About Lack Of Savings

A former colleague stumbled upon this blog recently and sent an email asking for some guidance on his financial situation.  David (name has been changed) works in the public sector in Alberta and is a married father of three young children.  Here’s what he wrote:

I am one of those folks who abhors debt of any kind – not just consumer debt, but also mortgage, car – doesn’t matter.

My wife and I purchased our first home back in 2010.  We paid $348,000 for it.  We had what we thought was a 10 percent down payment at the time, but did not consider closing costs, etc., so that down payment turned out to be a bit less.

Related: How much house can you afford?

Since that time, I’ve been working very hard to melt that away as quickly as possible.  Each year, I increase the biweekly payment amount.  In addition, I regularly put extra monies toward the mortgage, where possible.

We are doing well, having paid $86,000 toward the principal since July, 2010. The issue, though, is that of savings.  Rather than sock extra money away in savings, I find myself putting nearly everything (save RESP contributions) into the mortgage.

Of note, I do contribute to the Local Authorities Pension Plan (LAPP), so the pension savings are there.  I have RRSP’s built up in other jobs, too, so I don’t feel as though I’m compromising there.

Is this a sound approach, in your view?  I’ve been doing this for the past number of years (as we were building up a down payment before taking on the house), so I’m used to it.

Related: Should I pay off my mortgage early or invest?

My issue, of course, is that if something happened, we don’t have that much in savings.

It’s clear that David wants some reassurance that his mortgage-slaying approach is the right one.  He emailed the right person because his financial situation and money fears are eerily similar to my own.

Here was my response to David:

Hi David, I can definitely empathize with your situation, as we recently bought a home that came with a $300,000 mortgage and I’d love to pay it off sooner than later.  However, I try to take a balanced approach when it comes to saving, investing and paying off debt.

Consider your goals and your risk tolerance.  If you hate debt and just want to get rid of it, your plan makes perfect sense.  To alleviate your fear around not having any other savings, consider scaling back your mortgage prepayments a bit and divert some cash into a high interest savings account.  Once your mortgage is fully paid then you can start to ramp up your retirement savings and keep more cash on hand.

Something else to consider:  The pension plan is great if you stay in your job long enough to reap the benefits, but if you change jobs often then the plan won’t be worth as much to you long term.  That’s why it’s important to diversify your savings through your RRSP and TFSA in addition to your pension plan.

Related: Will a pension plan handcuff you to your job?

The reason I take a balanced approach is that, like you, I don’t want all of our net worth tied up in a house and a pension.  They’re not liquid investments that can easily be sold off should you need the money.

We have $2,500 a month left over after all the bills are paid.  From that extra cash flow, we put an extra $1,100 a month on the mortgage, $300 a month goes into a high interest savings account (for short term goals, and a bit of an emergency fund), $200 a month goes into RESPs, and $900 a month goes into RRSPs.  Like you, I have a pension, but I have unused RRSP contribution room from other jobs.  Once I’ve used up my available RRSP contribution room, I’ll divert $600 a month into our TFSAs.

Your tax free savings account is your friend, for both short-and-long term savings goals.  I regret not saving more in my own TFSA, but the reality is there is only so much to go around, so I prioritized the mortgage and RRSP first.

Also, I have a variable rate mortgage at 2.2 percent.  One could argue that long term investing will yield more than the cost of borrowing at that rate, but there are no guarantees that will happen.  Paying off the debt is a prudent strategy.

Final thoughts

David currently puts $3,000 per month towards his mortgage (monthly payment is $1,500) and, if he continues at this pace, will have a fully paid off home by September, 2020 (just over 10 years after buying the house).

Related: How to pay off your home faster

However, if David decides to ease up on the mortgage payments and instead directs $500 per month into a high interest savings account, or tax free savings account, he’ll only delay mortgage freedom day by 20 months (April, 2022) and he’ll have $100,000 in cash savings.

Something may come up where he needs that money, but it maybe not.  If the cash isn’t needed then David still has the option to make a lump sum contribution to his mortgage at any time to help pay it off faster.

Readers: What do you think about David’s financial situation?  Should he keep doing what he’s doing, or relax on the mortgage payments and find more balance?

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14 Comments

  1. Money Saving on December 2, 2013 at 6:27 am

    Everyone has a different level of risk tolerance. I think you gave David excellent advice. I used to be in much the same boat as David.

    But, I decided that I need to shift the level of risk that I’m willing to take to really get ahead when I reach my 40s and 50s. There is nothing wrong with David’s approach. But, the long term rate of return in the stock market is much, much higher than ~3%. The question is, how much pain can someone endure if we hit a rough patch and see multiple years of negative returns. For some folks, they do not have the mental ability to weather the storm…

  2. Ed on December 2, 2013 at 8:47 am

    I found this article of a personal interest. Savings, mortgage, RRSP, TFSA, RESP, 2.2% mortgage (where is this available?), retirement fund. YOU HAVE $2500.00 left over after paying all of the mentioned? Not sure what your income is but it is not what the average one income household is in Ontario.

    David is in his 30’s where everything can happen and does happen. More children, newer cars, furniture, vacations, appliances, jewellery, clothes, food, entertainment, events, and so much more. Savings is a rumour at this age.

    What David should have considered is his compulsion to remove debt before incurring debt. Purchasing a home of less value would definitely ease his conscious of debt. Less initial cost, less property tax, insurance, less realty fees, banking fees, etc. David is working hard, great, but is David enjoying his house, wife, children, life? Balance is the trick but when you try to balance your life, your families lives, finances, work and other things you must be a qualified magician.

    All is not doom in gloom. In your forties you will look back and say it was not so bad. Do not worry so much about the mortgage and wake up and smell the coffee. Sounds like you have a good life and it is time to embrace those around you in and enjoy the ride. Mortgages do diminish, just give yourself a realistic time line and expect the unexpected.

    Great book called Don’t Sweat the Small Stuff is in order here. This is my unsolicited two cents. Good luck to you David and Robb. Keep advising and writing.

    • Echo on December 2, 2013 at 8:48 am

      Hi Ed, I got my variable rate mortgage in 2011. The $2,500 cash flow is after expenses, so that’s what I use for savings, RRSP, RESP, and extra mortgage payments.

      Thanks for your words of wisdom – makes a lot of sense!

  3. AdinaJ on December 2, 2013 at 8:57 am

    I’m also in the same boat as you, Robb (and David), and taking a similar approach. We hope to have our house paid off about 13 years after buying it (in 9 years or so), but we started with a higher principal. We have RRSPs, TFSAs, and an RESP for our kids. none of them quite maxed out yet, but we are working on that. Some days it feels like we’re barely making any headway, despite having good incomes and saving a big chunk of them. I just have to remind myself that we are in the midst of our worst years money wise (small kids, maternity leave, etc.), and still making progress every month, so it’s ok.

  4. Alan on December 2, 2013 at 11:36 am

    I think David is on the right track. To me it makes no sense to put money in a taxable high interest savings account rather than pay down the mortgage. The after tax return on a 1.5% savings account is approx. 0.9%, compared to the guaranteed return on your non-deductible mortgage interest rate, which is likely to be 3 or 4 times greater. You might consider a line of credit for emergencies, but don’t use it for non-emergencies! You’d have to crunch the numbers, but one good strategy might be to contribute to your RRSP and use the tax refund to prepay your mortgage.

  5. Bet Crooks on December 2, 2013 at 5:56 pm

    I’ve always known that we didn’t think about our mortgage the way some people do: To us, it was just a glorified kind of rent. We never included any equity in our home in our net worth estimates. But we also never included the mortgage in our debts. We just paid a whopping big payment to the bank every two weeks and every so often dropped a principal pre-payment on top. (We did like reducing the interest we paid we just didn’t think of the principal as a “debt.”)

    We did make regular contributions to our RRSPs and we did have easy-to-cash savings for emergencies. (There were no TFSAs then. Now I would max out a TFSA first and then start on a RRSP.)

    Having experience with two communities where the value of houses dropped below the mortgages people still had owing on them is probably why I don’t consider putting all the money towards a mortgage a good idea. My unease is probably not justified but it did affect what we decided to do.

  6. Daniel on December 2, 2013 at 9:57 pm

    I’m very much in the same boat and trying to weigh my options. We’ve reduced our amortization period from 25 years down to 10 in the last five because of some mad debt aversion. We’ve been trying to pay down as much principal as our savings will allow but with interest rates the way they are, wouldn’t it be a little more prudent to stash it away in retirement savings?

    Unfortunately, I got caught up in the doom and gloom of potentially rising rates and recently renewed our mortgage term for 5 years @ 3.29% before the BoC dropped their mention of rate hikes. Bummer.

    We’re considering moving to a bigger place so our savings are currently distributed into RESP(20% match!), TFSA (for future down payment), RRSP (where it makes sense), mortgage.

    @AdinaJ ah small kids, maternity leave. i feel your pain. and joy.

    • Bet Crooks on December 3, 2013 at 7:05 am

      @Daniel,
      Make sure you take lots of time to discuss moving to a larger home with your partner. We know three families who decided to stick with the smaller home but fix it up extremely nicely inside. All 3 are very pleased 5-7 years later with their decision. Especially since they saved a lot of $$ on both the selling/moving/buying costs and on the property taxes and maintenance bills, money which they’re enjoying using in other ways including travel during “peak” times like March break. (And yes, children did have to share rooms for a while.)

      While for some it really is critical to move “up” for others it’s worth reviewing whether it really matters.

      • Daniel on December 3, 2013 at 7:45 am

        @Bet Crooks,
        Thanks for the sage advice. We’re currently in a 2bdrm condo. The space currently meets our needs but adding a 2nd little one would be a bit of a squeeze. No other ways about it, the children would share other room.

        We’ve ultimately decided to stick around for another 3-5 years simply because too much added debt would hinder our ability to meet our financial goals. As much as I want a bigger space, we definitely want to keep travelling and meet other priorities.

        When we reach critical mass and if the bubble still hasn’t popped, I guess we’ll have to weight renting vs. owning. Have a magic 8 ball handy?

        • Bet Crooks on December 4, 2013 at 5:39 pm

          Sounds like you’re giving it lots of time and lots of thought!

          You’re right that it takes a bit of magic sometimes to make the right decision.

          Best wishes!

  7. My Own Advisor on December 3, 2013 at 7:58 pm

    Paying off debt is always smart but I would suggest working on the TFSAs, if only a little bit.

    Tax-free is tax-free. With registered accounts like the RRSP, hard to know what tax-rates will be in the future.

    Take the gift while you can.

    Good advice Robb but I expect nothing different 🙂
    Mark

  8. Judy on December 4, 2013 at 8:51 am

    I think it is important for everyone to have an emergency fund. Things happen, it’s just a matter of time.

    I like your idea of putting $500 per month into savings. Canadian Direct pays 2.25% on their TFSA. I prefer to fund my TFSA before my RRSP because with taxes it’s either pay them now, or pay them later. I prefer to pay them now while I am working and can easily afford it.

  9. fiscally fit on December 4, 2013 at 12:54 pm

    What about a readvancable HELOC instead of a mortage? or a hybrid, part fixed mortgage part HELOC. Should have enough equity in the home. The balanced approach seems to work best but the HELOC would allow access to funds in case of emergency. I would hate to have idle cash sitting in a “high” interest saving account when it could be working a little harder for you.

  10. Devin on December 8, 2013 at 9:56 am

    In the message above it sounds like you have 2 goals. 1 be debt free. And 2 have an emergency fund. The thing I noticed is you are only focusing on one goal. My suggestion is to figure out what your goals are and prioritize them so you can make an informed decision. This way you do not neglect the other goals unless you consciously make the decision. Oh the choices in life.
    FYI. Also an Albertan in the public sector, 35, debt free (mortgage paid of 2011 purchased in 2006), 2 kids (maxed to matching RESPs) and soon to be maxed out on TFSA and RRSP. So it is doable just not all at once. Keep up the good work.

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