At first glance, it’s difficult to see why Francesca Nazario is so worried about money. She and her husband Guy, both 36, own a three-bedroom bungalow in Whitby, Ont., an hour’s drive from Toronto. They have two young kids—Amelia, 3, and Sam, 15 months—and a combined income of $130,000 a year.
But Francesca, who earns $50,000 a year as a secretary with a small manufacturing company, feels that she and Guy aren’t in control of their finances. The clearest evidence of this is the $42,000 of personal debt they’ve accumulated—and that’s on top of the $350,000 mortgage and the $20,000 they still owe on Guy’s 2016 taxes for his consulting business. “We’re making decent money but we’re going deeper and deeper into debt,” says Francesca. “Why can’t we make our finances work?”
The Nazarios (whose names we’ve changed to protect privacy) aren’t frivolous with their money. They bought their home four years ago in a nice subdivision. “It’s what we could afford and we’re glad we bought when we did,” says Francesca. “We’d never be able to afford a home now.” Plus, the family annual expenses are modest—$8,000 on groceries, $1,500 for restaurants and $1,000 for their camping trip. Still, they’re taking on more debt each year. “I hate debt and want to clean up our finances,” says Francesca.
Drop in family income certainly hurt
Part of the problem is that Francesca was on back-to-back maternity leaves. That drop in the family’s income combined with an unfortunate decision made four years ago really hurt the Nazario’s financial position. In 2012, rather than pay tax owed on Guy’s self-employed $80,000 per year income, they opted to use the money as a down payment on their current home. Guy eventually paid the tax owed, but it meant not paying his 2016 taxes. Now he owes the Canada Revenue Agency another $20,000 in income tax.
Now, the Nazarios have some big expenses, including a $1,000 payment every two weeks on their accelerated mortgage as well as a $23,000-a-year daycare bill for their two young kids. Any money left over is used to pay down their $20,000 line of credit—but that means they’ve been ignoring the tax owed on Guy’s self-employment income. “We throw what we can at the debt and keep $9,000 in emergency savings—just in case I lose a client,” says Guy.
While they think they’re in a good position to get back on track, mainly because Francesca is back at work, they feel they’re struggling. This year they’ll see a deficit of $8,674 and they’re afraid they’ll start eroding their assets if they don’t tackle their debt fast. She believes their best bet is to put themselves on a strict debt repayment plan. “We have two kids now,” says Francesca. “It’s time to start hunkering down with our debt and moving the family forward.”
What the experts say
Toronto financial planner Heather Franklin says the Nazarios have to take action now. “They need to focus on repaying their debt and can’t wait any longer.” Here’s what the Nazarios should do.
Pay income taxes now
Not paying income tax always comes back to haunt you. “The penalties are severe,” says Cleo Hamel, senior tax analyst with H&R Block Canada. “They’ll pay 1% a month in interest on any overdue balances.” That quickly adds up, says Franklin. Instead, the couple should use the money in their emergency fund savings account to pay down the back taxes owed. “They can draw on their line of credit in an emergency,” says Franklin. Then take $15,000 out of Francesca’s RRSP*, pay the $4,000 tax on the withdrawal and use the remaining $11,000 to completely pay off Guy’s 2016 tax bill. “She was on maternity leave so her tax bracket will be fairly low,” says Franklin. The couple should also reduce stress by having Guy deduct 25% from every cheque he receives and put this money in a savings account controlled by Francesca, who is the one cracking the whip and can send the money to the CRA each quarter. By pre-paying his income tax, they can avoid the strain of a big year-end tax bill.
In February, when Sam is 18 months old, the Nazarios will be able to reduce their daycare bill by $4,000 annually. The couple should also stop making their $900 RESP contribution until they’ve paid off their personal debt, as well as cut miscellaneous expenses by $2,000, gift buying by $500, their restaurant bill by $500 and their groceries by $500 for a total of $8,400 in savings. “These cuts will get them in the black next year,” says Franklin. But they’ll need to avoid adding any more debt in the next three years to stay on track.
Stop accelerated mortgage payments
“They’ll shave $3,000 off their annual mortgage bill by shifting from biweekly to monthly payments,” says Franklin. While paying down a mortgage is a good idea, it shouldn’t be top priority right now.
This year and beyond
The couple should take the $15,000 they put towards their line of credit payments and apply that to credit card debt, instead. “They should only pay the $1,000 in interest on the line of credit next year,” says Franklin. Then use any extra money to pay down the $20,000 line of credit. Do this in 2018 and 2019 and they’ll have paid off all debt, aside from their mortgage, by mid-2019. Only then should they go back to aggressively attacking their mortgage. At that point, they could also resume contributing to RRSPs and RESPs—but only after congratulating themselves for escaping from their debt trap.