Alfonso Delgado can still remember clearly how excited his family was when they first arrived in Canada from Venezuela five years ago. He had just gotten a much sought-after job transfer, and his wife Carmen and their three-year-old son Aldo were eager to explore their new home city of Toronto. “We arrived on a cold December night in 2005,” says Alfonso, 34. “We had just spent a year in North Carolina and though we liked the United States, we weren’t happy with their melting pot approach to life.”
Alfonso works as a systems analyst with an international financial services company, earning $104,000 a year. So far, he likes it here, and hopes to stay in Canada for at least five to 10 years before his next transfer. He’s well-educated, with an honors BA in computer science and a masters degree in finance from the Universidad Central de Venezuela. But even so, he is quick to acknowledge how little he knows about personal finance. “My ignorance regarding money has caused us a lot of grief,” says Alfonso. “It’s been a nightmare. I now realize how woefully unprepared I was to make some of the financial decisions I have had to make for my family.”
The sad truth is that the Delgados are drowning in debt (we’ve changed their names and some other details to protect privacy). They’re just starting out, but they’re already in the hole by almost $400,000. They have hardly any equity in their new home, they’re leasing an expensive Lexus car, and they have $34,000 owing on high-interest-rate credit cards and a line of credit. “All of our troubles started when we bought our townhouse three years ago,” says Carmen. “We rented a house for a year or two and we were fine. Then we got caught up in the dinner talk about real estate as a great investment and we bought a home before we were really ready. We’re still suffering from that decision today.”
That home, a $400,000 four-bedroom townhouse in Mississauga, Ont., was purchased in 2008. Alfonso’s first big mistake was to lock into a pricey five-year fixed-rate mortgage at 5.9% to buy it. He then watched in horror as variable mortgage rates plummeted to 2.5% over the following year and a half. “I couldn’t believe what a stupid mistake I had made,” says Alfonso. “When I tried to change the mortgage terms, they wouldn’t let me. I was stuck.”
Then real disaster struck. In March of this year, Carmen’s mother died from breast cancer and in May, Carmen’s sister Maria died suddenly from complications resulting from minor stomach surgery. After helping the family out with medical expenses and other costs, the Delgados were further in debt than they had ever thought possible. “Airfare alone for just myself cost $4,000 for each trip because it was last-minute,” Alfonso says. “We also helped the rest of the family out with medical bills. It broke us.”
As they had no savings, Alfonso had to put all of the unforeseen expenses on his five credit cards, at rates between 12% and 19%. That debt quickly ballooned to $29,000 and Alfonso began to panic. He felt there was no way he could keep making the $2,300 monthly payment on the mortgage for their townhouse without going bankrupt. Eventually, the family decided they couldn’t afford the house any more. They would have to downsize to a cheaper place.
At first, the Delgados thought they could sell the townhouse, repay their mortgage and rent for a while, but they were quickly convinced by a local real estate agent that moving to a less expensive home was a better solution. “He told us, ‘Why throw your money in the garbage by renting?’” says Carmen. “We were soon convinced that selling our house and buying a new one that was $40,000 cheaper would solve all our financial problems.”
But when they contacted the bank to get out of their existing mortgage, there was a snag. If they sold off their home and tried to pay back their fixed-rate mortgage, the bank would hit them with massive $21,000 penalty. The only solution, they felt, was to transfer their existing $346,000 mortgage to the new property to avoid the fee. That would free up equity from the townhouse sale to pay off some debt, but they had to keep their original 5.9% fixed-rate mortgage, with pretty much the same monthly payments, until the term was up in January 2013.
Unfortunately, much of the $40,000 they freed up from the sale was devoured by the expenses of the move. It turned out they would have to put a 10% down payment on their new home—not 5% as they previously thought—because of their debt load and the fact that Alfonso had a work visa. Then there was the $20,000 commission for the real estate agent. “The worst thing is that I found this house myself and arranged all of the financing myself,” says Alfonso. “The real estate agent didn’t do anything for us, yet I paid a hefty commission to him. It’s very demoralizing.” The couple moved in to their new home in Oshawa, Ont., in August, but so far, they aren’t seeing any savings to their monthly expenses whatsoever.
Alfonso and Carmen first met while attending university in Caracas. Carmen was studying Spanish and Alfonso was studying computer science and business. Their parents helped to pay for most of their university expenses and the two graduated debt-free.
Right after university, Alfonso got a job with a retail distributor and in 2001, just before marrying Carmen, he landed a lucrative job with his current employer. In 2003, his son Aldo was born (followed by a second son, Piero, in 2009), and in 2004 Alfonso got a job promotion and transfer to North Carolina. “It’s a beautiful place,” says Alfonso. “The weather is great, except for the hurricanes. But I was very curious about this multicultural country that welcomed immigrants, and I jumped at the chance to be transferred here.”
Now, much of that early optimism is gone, replaced with fear about what the future will bring. To help reduce their debt load, they recently put in an application to one of the Big Five banks to consolidate all their debt. But they may not be successful. If they are, they can reduce the interest rate on all their credit card debt and their line of credit debt to an annual rate of 9%.
They’re also hoping to tap into some stock options Alfonso’s employer gave him two years ago. In February Alfonso will be eligible to cash in one-third, giving him $10,000 gross ($6,000 or so after taxes) from the sale. He can cash in similar amounts in 2012 and 2013. Alfonso also gets a $10,000 bonus every year ($6,000 after taxes). “I usually get that bonus in the spring of each year,” says Alfonso. “Debt or emergency fund? I’m not sure where to put that bonus money.”
Finally, the Delgados are confused about whether they should open a Registered Education Savings Plan (RESP). They want to be good parents and they’d like to help their eldest son Aldo go to university. And while Carmen wishes she could work and contribute to the household finances, Alfonso’s work permit heavily restricts where she would be able to work. “The work visa has tight restrictions,” says Alfonso. “We’d be afraid of violating them. It doesn’t leave Carmen with many job options at all while we’re in Canada.”
For now, the Delgados just want to get back in the black. The stress is really starting to get to Alfonso. “I used to go to the gym three times a week before this financial mess,” he says. “Not anymore. I need to get back to living my regular life the way I did before everything got so complicated.”
What the experts say
Most people believe that buying real estate is always a good investment. That’s not true, especially if, like the Delgados, you don’t plan to live in your home for more than 10 years. “The Delgados should have rented for the few years they were going to be in Canada,” says Barbara Garbens, a fee-only financial planner in Toronto.
Homeowners tend to downsize because they want to free up equity in their home, but when the Delgados sold their townhouse, they didn’t have much—barely $40,000. That’s not enough to make downsizing worthwhile. “Unless you’re moving from a monster home where you lived with six kids to a small, modest condo, downsizing often doesn’t make much financial sense,” says Mary Prime, a fee-only financial adviser in Toronto. “After real estate commissions, legal fees, land transfer taxes and moving expenses, the Delgados saved practically nothing. I think they panicked and made a rash decision.”
When choosing a mortgage, it’s wise to keep in mind that many fixed-rate mortgages, like the one the Delgados have, are very restrictive. There are large penalties if you break them, and there’s little flexibility to renegotiate if your financial situation changes. “It’s important to have a lawyer look at any mortgage contract and explain it to you fully before you sign,” says Garbens. “It’s cost the Delgados dearly not to have done that.”
So what can the Delgados do to get out of this mess? Here are our experts’ suggestions:
Don’t move again
Whatever happens, the Delgados should not move again while in Canada. Stagnating real estate prices coupled with hefty moving fees won’t make another move financially feasible for years. “I give Alfonso full marks for recognizing the trouble he was in,” says Prime. “His antennae went up and that’s a good thing. But he now needs to really settle down and fix his finances.”
Slash the luxury spending
The couple needs to reduce their monthly expenses. “The Delgados certainly don’t overspend but for the next 18 months, they need to do everything they can to cut costs and put the excess cash towards the debt,” says Prime. They can start by trimming their $1,800 restaurant bill, the $2,760 they pay for clothes and haircuts, as well as the $4,000 they spend on vacations. Cutting those bills in half will save them a hefty $4,000 a year. Then, when their car lease comes up, they should consider leasing a cheaper vehicle. “Those savings, too, should go towards their debt.”
Pay off their line of credit
Right now, the Delgados owe $5,000 on their line of credit. They should pay this debt off quickly—even before the higher-interest credit card debt. That way, if there’s an emergency, they will be able to tap into the line of credit again if they really need it. “The line of credit can serve as their emergency fund,” says Garbens. “They can use part of Alfonso’s bonus early next year to pay off whatever’s left of this debt at the time.”
Cash in their options
In February, Alfonso should cash in one-third of his options, which will net him about $6,000 after taxes, and put that money towards his credit card debt. If his application by the bank for a consolidation loan at 9% is accepted, then he can just put the money towards the new lower-interest loan instead. He should do the same thing with his options in 2012 and 2013. This, along with his monthly payments, should help to eliminate his debt in two to three years.
Consult a mortgage broker
When the couple’s fixed-rate mortgage expires in two and a half years, they should seek the advice of an experienced mortgage broker. The couple should interview several of them, to see which one has the best ideas for getting them out of their debt trap.
They’ll find that most brokers will probe them more closely than a bank regarding what they really need in terms of their personal mortgage situation. “I know it’s difficult to find people you can trust, but this is a start,” says Garbens. “It will probably make sense for them to go for a variable rate mortgage, but they need to ask the right questions. Is the mortgage transferable? Are there prepayment privileges? Are there any fees for breaking the mortgage early? All of these questions need to be asked before signing the bottom line when they go to refinance.”
Forget the RESP
There’s too much uncertainty about where the Delgados will be in 10 years. And “if their kids don’t go to university in Canada, they will have to repay the grant money,” says Garbens. “So those dollars need to be earmarked for debt reduction.”
Visit a credit counsellor
Hopefully, the Delgado’s application for a consolidation loan at 9% will be accepted. If it is, they can opt for a three-year debt repayment schedule. That means they will pay about $960 a month. But if their consolidation loan application is rejected, or they find they need more help, they should seek the advice of Credit Counseling Canada. “They’ll do a full review of their financial situation and work out a repayment plan for them,” says Garbens. “They’ll even help renegotiate the terms of the credit cards for them. It’s a great resource, especially if they need impartial financial advice in the future.”