As we enjoy the great times of the summer season either on the dock, in a canoe or randomly “high-fiving” a stranger on a patio watching the Blue Jays hit another home run, the hot housing market conversation will come-up. As I write this story, a gen-x’er has made an outrageous offer unconditionally on a fix-me-upper in the GTA and without a blink of an eye, entered into a thirty-year mortgage that made the baby-booming seller start retirement. As this seems like a normal occurrence passed down from generation to generation and the prices are all relative to inflation and the metrics that compose the symphony of time and money, the truth is, affordability is being justified without including retirement and risk management costs in the total debt servicing ratio(TDSR) when applying for a mortgage.
According to the Canadian Institute of Financial Planning, mortgage lenders calculate both the TDSR and the GDSR-Gross Debt Service Ratio of an applicant to determine if they can realistically afford to make mortgage payments. The GDSR calculation adds the payment of principal and interest on a mortgage plus property taxes plus heating costs plus fifty percent of condominium fees divided by the gross income of the applicant(s). If the answer is 25% - 32% of the applicant(s) income before tax, BINGO! Another baby-boomer can retire. The TDSR is the same calculation; just add payments on other personal loans (cars, school, you get the idea). The TDSR percentage, however, should be within 35% - 43% for the bingo hall experience. Although these are only guidelines and not policy, I believe that these guidelines should include retirement savings as well as risk management costs (Long-term, short-term, critical illness disability and life insurance) to ensure that all of the financial planning bases are full before you go to bat.
As it has been surveyed by many of Canada’s largest financial institutions, a high percentage of baby-boomers will have debt and inadequate savings into their retirement years. These surveys may suggest that many boomers will be looking to downsize their homes to fund their retirement. Can you say “Supply”? According to the 2011 Census, 9.6 million persons, or close to 3 Canadians out of 10 (29%), were baby boomers. According to the same 2011 Census data, 9.1 million people, or 27% of the total population, belong to the children of baby boomers generation. These people were aged between 19 and 39 in 2011. This generation is often called Generation Y or 'echo of the baby boom.' Can you say “demand”?
Now keep in mind that this story is not meant to suggest or comment on the Canadian housing market rising or declining based on these facts, but rather acknowledge that these two statistics are factors in the euphoria of the current housing market. In my last ten years helping people feel good about their future and the next generation, the one common theme I find in my fact-finding process, is that their personal residence is the largest asset in their portfolio. Good or bad, right or wrong, it is what it is. So, when adding this asset class to your portfolio, do you think about the cash flow necessary to fund your retirement savings, income protection plans and the guidelines required by the lender? If the answer is no, then your financial plan is a financial hope; that the next generation will buy your home to fund your retirement.
Here is the good news; it only takes 10% to 30% savings of your gross income to fund 70% percent of your pre-retirement income. 10% if you are starting to save under 40 and 30% if you are 50 plus. Insurance can be provided at a low-cost through your employer or purchased for no more than 5% of your gross income to protect 100%. If you earn a combined family income of $100,000, and you are under 40, $10,000 should go to retirement savings and $5,000 should go to your insurance needs. This will leave you to defend your lifestyle costs and mortgage affordability (based on the lenders’ guidelines). Now for the bad news; if you aren’t addressing your savings and protection responsibilities while following these guidelines; you may face financial stress, marriage loss, getting ready for work at seventy years old or many of the challenges Canadians face when they are not prepared for their road to retirement.
Home ownership is one of the greatest ways to build the foundation of a sound investment plan. However it is not the only responsibility to your future. I feel that if we, as Canadians, address retirement savings, protection planning and responsible debt management as a base, we can make your working and retirement years dependable and the next generation greater.