Family profile: The big illusion

You couldn’t be blamed for thinking that Lucas and Penny are living the Canadian dream. She runs her own upscale hair salon in downtown Montreal. He’s an advertising salesman for a national media company. They live with their 11-year-old daughter Janet in a stunning half-million dollar house. Designed by an up-and-coming local architect, their showpiece home sits perched on a hill overlooking the city. With large windows and minimalist furniture in red and black throughout, it could easily be featured in Architectural Digest. There are huge closets for Penny’s stylish wardrobe and an outdoor kitchen perfect for entertaining. A new BMW sits in the driveway. Between them they pull in a healthy $200,000 a year.

But while they look like they have it all, the Andersons have a secret: their sumptuous lifestyle is a sham. The truth is they’re drowning in debt. They have hardly any equity in their showy properties, they’re leasing their car, and after you subtract the overhead on Penny’s salon and their income taxes, they really only have about $100,000 a year coming in the door.

For years, the Andersons have lived in denial. They thought they were being smart by taking advantage of super-low interest rates to support the same lifestyle that many of their friends seemed to be enjoying. Not only did they borrow to buy the hair salon and their home, they borrowed to buy their RRSP investments too. But lately cracks have begun to appear, and when they finally ran the numbers earlier this year, they had the shock of their lives.

They found that they’ve managed to build up almost $600,000 in debt in just four years—including a $300,000 mortgage on their house, a $200,000 mortgage on the salon, a $50,000 investment loan, and $8,500 on their credit cards at 19.5%. On top of that, the investments they borrowed to buy are performing terribly. Servicing their debt is sucking up all of their free income, and despite appearances, they’re not living the high life at all. “We can’t even afford to take a nice vacation,” says Lucas, 41. “We’re obviously hemorrhaging money with the two huge mortgages. It’s stressful for us because we can feel the debt piling up and we don’t want to live like this. Things have to change.”

It’s amazing how quickly the Andersons destroyed their finances. Up until 2008, they lived in a modest three-bedroom semi-detached home on the outskirts of Montreal that they had paid off in 2001. But they didn’t like their run-down neighbourhood and when they spotted their dream home two years ago, they bought it within 15 minutes of touring its spacious interior. “We had seen the home several times before from the outside, because we passed by it at least once a week when we ran our errands,” says Penny, 51. “Our friends had their home designed by the same architect and when we saw that this one was for sale, we raced over to see it. It was perfect—bright with clean and modern lines, and great for entertaining. We bought it on the spot without giving much thought to what it would do to our finances.”

Then there’s the investment loan. The couple’s adviser encouraged them to take out the loan soon after they bought their dream home, mainly to get some tax breaks. But after putting the $50,000 loan into mutual funds, they watched in horror as the funds fell in value to about $32,000. Lucas also took out a $23,000 RRSP loan, and that turned out even worse. It was used to buy dubious labour-sponsored investment funds that performed so badly, Lucas says, that withdrawals from the fund may have been temporarily frozen. “The last three years have been an education for us,” says Lucas. “Buying investments with borrowed money has been a total waste of time for us. I don’t know what we were thinking.”

The Andersons are starting to panic. “We really don’t have a clue as to what’s going on with our stocks and mutual fund investments,” says Lucas. “My investment adviser talks circles around me. We’re concerned, we’re over-extended. We need to stop bleeding money—now.”

Lucas and Penny know what an ordeal it can be to live in a household where every day is spent trying to make ends meet. Both were raised in Montreal, in single-parent households. Lucas’s mother was a single mom at 18 and things were always tight financially. “My mother was kicked out of her home at age 18 because of the pregnancy,” says Lucas. “No one taught her how to be good with money. She just worried about putting food on the table for my sister and me.”

Penny’s dad died in car accident when she was just seven years old and her mother was left to raise Penny and her younger sister on her own. Penny says both her parents were good with money. “My father had been a businessman and, among other things, ran a laundromat,” says Penny. “My mother took over when he passed away and even though she didn’t have a great business mind, she made it work. She often got behind in her debt payments, but she’s actually really good with money now and a great saver and investor.”

After Lucas finished high school, he immediately took a job waiting tables—a job he did for 10 years in different parts of the world. “I lived in Vancouver, London and Paris,” says Lucas. “I just wanted to travel and I did.” At 28, he went to Dalhousie University to study music and when he returned to Montreal, he continued to work as a waiter while performing a couple of evenings a week with his band at various clubs. “I was always terrible with money but I always felt rich. I never saved. Mind you, I never made much in my 20s but I had my music and my friends and I was happy.”

In 1991, Lucas met Penny, who was working as a hairdresser in a hair salon above the Italian restaurant where he worked. The couple started living together right away. In 1992, Penny, who is 10 years older than Lucas, bought a modest house on the outskirts of Montreal and in 1997 the couple officially married. Soon after, in 2000, their daughter Janet was born, and Lucas, who had taken marketing night courses in the late 1990s, quickly climbed the ranks in the marketing department of the media firm he still works for today. “We lived in that house for 16 years and had the mortgage paid off by the time Janet was three,” says Penny. “It was a nice house but the neighbour­hood was run down and we had talked about moving off and on for several years.”
That’s when their life got complicated. In 2006, Penny decided to buy an investment property that would house her own hair salon. After paying $200,000 for the salon and putting in $150,000 worth of renovations, the couple was left with a $225,000 mortgage. Then in 2008, the couple bought their dream home for $525,000. Looking back, they agree it was a financial mistake. The problem is, now that they’re living there, they aren’t willing to give it up.

But if they don’t sell, something else will have to give, and it will likely be painful. “We have to get out of this trap,” says Penny. “We’re not willing to live like paupers for 15 years. We need to get back to building meaningful savings. We’re prepared to do whatever it takes to do that.”

How the money is spent

What the experts say
The experts agree that the show is over. Lucas and Penny Anderson simply can not afford the lifestyle they’re currently living. They never could. That means that either the dream house or the hair salon will have to go. “I know how people feel about real estate, but maintaining two properties is unaffordable for this couple,” says Marc Lamontagne, a fee-for-service adviser in Ottawa. “They’re living beyond their means.”

Barbara Garbens, a fee-for-service adviser in Toronto, agrees the situation is dire. And it’s compounded by the fact that the Andersons are running out of time. “They aren’t saving any money, they have about $112,000 in dubious in­vestments and Penny is just a decade away from retirement,” Garbens says. “If they don’t sell one of their properties, their cash flow will be tight for years to come. I don’t think they want that.”

Here’s what the couple needs to do to get back on the right track.

Where they stand

Sell a property
Our experts agree that the best solution is for the Andersons to sell their unaffordable home and downsize right away. The problem is, the Andersons refuse to give it up. “Homes are a very emotional investment,” says Lamontagne. “People say they want to downsize but it’s very difficult for most people to do that once they’ve gotten used to a certain neighbourhood and standard of living.”

That leaves only one option: sell the salon. If they do, that would leave them with about $143,000 in cash after the sale, $80,000 of which Penny would have to use to renovate the basement of their home into a replacement studio. That will leave them with $63,000 in cash.

Liquidate their mutual funds
Garbens wants the Andersons to sell the under-performing mutual funds at the same time that they sell the studio, then take the $32,000 from the sale and use it to pay off their debt.

Once the couple has sold their salon, renovated their basement into a replacement salon and sold their mutual funds, they will have $85,000 left in cash. Of that, $76,500 should be used to pay off all their personal debt while the remaining $8,500 should be put towards their mortgage. After they do all this, the couple will have trimmed their total mortgage debt to about $289,000 and with less money going to service their mortgage, they’ll have about $35,000 available to invest in their RRSPs each year.

Set up a plan
The Andersons need some discipline, and a detailed plan to help them stay on budget is crucial. Every year, they should invest $20,000 in Penny’s RRSP, put $10,000 down on the mortgage principal and put $5,000 towards a family vacation and other activities that they enjoy. When they receive their annual $9,000 RRSP tax rebate, they should immediately put it towards the mortgage. “The extra $5,000 of spending money a year gives them some breathing room to enjoy life a bit,” says Lamontagne. “But they must absolutely not spend the tax rebate. It should be applied to their mortgage consistently every year.”

Change their attitude towards debt
The Andersons need to carefully track their earnings and spending to avoid slipping back into debt. They should keep a journal of their net income and expenses for a few months, record every purchase they make and every bill they pay. They should also pay their credit card bill off completely every month. “If they’re only making the minimum payment, then they should put away the cards and stick with cash until that debt is paid off,” says Garbens.

Our experts say that the Andersons could have spared themselves a lot of anguish if they had followed a conservative rule of thumb when it comes to taking on a mortgage—make sure you can pay your mortgage and household expenses on only one spouses’s salary. This gives you a cushion of safety should one of you lose your job, get sick or go on maternity leave.

Finally, as the Andersons learned, borrowing to invest is risky. Never buy an investment simply because there’s a tax benefit, say our experts. Take some time to research the investment and only buy it if you feel you would have bought without the tax benefit. Otherwise, you risk falling prey to unethical advisers who are just looking for some extra commissions.

Get a real investment strategy
Buying in­vestments they don’t understand hasn’t worked out for the Andersons. Instead, they might want to try something simpler, such as a single low-fee balanced mutual fund, or a Couch Potato investment strategy using index funds. “Advisers haven’t served them well,” says Garbens. “It’s a bit of a mug’s game trying to pick the right one. But if the couple keeps on learning, they can do well with their investments on their own.”