Let’s look at the long term financial security of two families both aged age 30 that live in Victoria, earn $100k per year and wish to buy a $500k house. The Optimistic family has $25,000 in their RRSP’s and plan to withdraw this to buy that home and finance the rest over 35 years. They have been told this is a sound financial decision as interest costs and property taxes are less than the rent they are currently paying. They will have to pay back the $25,000 over the next 15 years into their RRSP, so they are told they are not robbing their retirement. This family would like to put money into their RRSP, but each year they simply have nothing left to invest given the high cost of living. This family manages to make all their mortgage payments and in 35 years they are mortgage free just as they retire.
The Balanced family is in the exact same situation, but has done a lot of research on financial planning and has decided they will save their $25,000 deposit while leaving their RRSP account alone. They save hard over the next year and learn how to live below their means. With this new found skill they decide they will pay off their house over the traditional 25 year period while maximizing their 18% RRSP contributions each and every year. Once their mortgage is paid off the Balanced family plans to invest their mortgage payment into the TSFA until they retire at age 65.
These families go about their lives and meet all their payments under the following economic circumstances for both:
- Inflation stays low at 1% allowing five year mortgages to stay a 4.25% throughout the next 35 years
- Their houses manage to appreciate at an average rate of 3% per year, a full 2% more than inflation
- RRSP and TSFA investment return on average 6.5% per annum
The chart below shows how the net worth of these two families increased over the 35 year period. Net worth is defines as the value of their house less outstanding mortgage plus the value of their RRSP and TSFA’s.
At the end of 35 years, both families own houses outright that are worth $1.4 million making their investments in those homes 35 years earlier look pretty good. But the big difference is that the Balanced family has investments worth over $3 million and the Optimistic family only has about $150,000 saved in their RRSP’s. The only way the Optimistic family can finance their retirement is to sell their house or take out a reverse mortgage.
You may say that this example is extreme, but if you research how much average families actually invest in their RRSP’s, the Optimistic family is like many typical Canadian families and most will have to sell their homes to support retirement. A key message here is that you have to save a lot more money for retirement than one thinks and it needs to far exceed the value of your home. Although three million dollars may seem like a lot of money it is actually about what a 30 year family will need in 35 years to properly support themselves under the above economic assumptions.
Proper financial planning will not stop you from buying an overpriced house, but only make you realize that you must factor in proper retirement and other financial matters into the overall buying decision. For most it takes many decades to generate real wealth, but it can be achieved.