Friday Reader Case: Would You Rather Have One Million in Debt or One Million in Assets?

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FIRECracker

FIRECracker is Canada's youngest retiree. She used to live in one of the most expensive cities in Canada, but instead of drowning in debt, she rejected home ownership. What resulted was a 7-figure portfolio, which has allowed her and her husband to retire at 31 and travel the world. Their story has been featured on CBC, the Huffington Post, CNBC, BNN, Business Insider, and Yahoo Finance. To date, it is the most shared story in CBC history and their viral video on CBC's On the Money has garnered 4.5 Million views.
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TGIF ‘cause it’s time for another Friday Reader Case! This reader writes to us from the GTA, Canada, and is having a dilemma about whether to sell her house and rent, or stay in her house. Without further ado, Take it away ScaredInGTA!

Hi Firecracker,

Hope all is well. I have been following you and find you very inspiring. My husband and I own 2 properties; one is being rented and the other is our main residence. We are planning to sell our rental property in the near future and are open to selling our house and rent. The problem is that we looked intensively for 1 year and couldn’t find anything that would make sense for us to sell. We also love our area, good school for the kids and very nice community. We love our house, not for pride of ownership but because we love to have a place to call home and stability.

Without being on the market we have people come to knock at our door to take a look at our house and we actually got a decent offer. I know it is probably the thing to do at this time because all the arrow is pointing towards the direction of real-estate going down. There is always a possibility that the opposite can happen. I am scared to take the kids away from the house they grew up in for leaving such a great community. I guess what I am asking since you are so good at it, is to help me calculate and show me that selling my house now is the way to go vs keeping it and view it as a long-term investment. We plan to rent for less than our current allocation for housing expenses.

Property #1: value $1.5m mortgage $680K weekly payment $735 for another 24 years at a variable interest rate of 2.9% property tax $7K
Property #2: value $700K mortgage $300K after all fees, we have a positive rental income of $150
We have some RRSP, RESP, TFSA ($100K). Some company stocks that are worth about $150K and one of us have a pension plan

Summary of our finances:

Monthly Family income (after-tax):  $11K/month

Category Spending
Housing: 5762
Phone Bill: 60
Food: 600
Transportation 1881 (car lease + gas + insurance + maintenance)
Clothing 140
Life Insurance 469
Personal 725
Total: 9636.81

Debt: $980K mortgage for 2 properties
Investible Assets: $100K (RRSP, RESP, TFSA). $827 for RRSP and $416 for RESP each month.

Please let me know what your thoughts are. We just want to make sure that we are going to be able to retire in 20 years if we want to.
Thank you,
ScaredInGTA”

Good God, ScaredInGTA, with a spending of $9636.81/month, you are spending 88% of your income! Which is fine when times are good, but what if one of your were to lose your job? If you’ve never lived through a recession, you have NO IDEA how painful that would be. It’s not fun. Trust me.

Looking at your housing situation, I can see that you have $680K + $300K = $980K in mortgage payments. So you’re in debt to the tune of almost a Million dollars! And given the new B20 rules, when it comes time for renewal, you may have to re-prove that you can afford the current Bank of Canada 5-year benchmark rate (5.14%) or 2% above your contractual mortgage rate.

Since you’re spending almost everything you make, so much of your wealth is locked in housing, you owe almost a Million dollars, and with tightened mortgage rules now in play, I can see why you’re scared. I’d be scared shitless too.

And now you have someone willing to take it off your hands for $1.5 Million? And you’re hesitating on this?
So you want to see the numbers? Okay, let’s see what happens if you were to sell both properties.

Property 1: $1.5 Million * 0.95 = $1,425,000 (after 5% agent fee). After paying off your mortgage: $1,425,000 – $680,000 = $745,000

Property 2: $690,000 * 0.95 = $655,500 (after agent fee). After paying off your mortgage: $655,500 – $300,000 = $355,500
Total net: $745,000 + $355,000 = $1,100,500

So all of a sudden you’d go from being almost a Million dollars in debt to a net worth of over $1.1 Million!
When you add your investible assets of $100,000, you’d get $1,200,500, which by the 4% rule would support a yearly living expense of $48,020/year!

But given your yearly spending of $9636.81 * 12 = $115,641.72, you’d need at $2.9 Million to retire. And at your current savings rate of 12%, that would take you almost 50 years!

Even if you kept your primary residence for emotional reasons–to keep your kids in the same school district, etc–just by freeing up the $355,500 you have trapped in the rental property, that would generate a yearly income of $14,220, or $1185/month using the 4% withdrawal rule. Right now, your cash flow is a measly $150/month. That’s only $1800 for the whole YEAR, which means you’re getting a return of $1800/$355,500 = 0.5%. I could get a higher return digging around in my couch.

This is exactly why I say people need to MathShitUp when they invest in rental properties. Seriously, do not do this if you have no idea what you’re doing. The cash flow on this rental property is abysmal. Invested in a diversified portfolio, your return for just one month is 8X what you’re getting in cash flow from the rental property.

Hell, even if the markets tank, just the DIVIDENDS of 3% on $355,500 gives you $10,665! And right now you’re taking a huge risk by locking $355,500 in one asset without diversification. If the housing market tanked or you get a bad tenant that screwed up your house, you’d be shit outta luck. THAT much risk for a measly gain of $150/month in cash flow? WHY, SIGTA? WHY?

So the choice is yours. Be almost a million dollars in debt or end up with $1.2 million in your pocket.
But the thing I really don’t get is why you need to spend $1881 on transportation AND $5762 on housing? If you’re spending that much on housing, you’re already close enough to everything you wouldn’t NEED a car—that’s what the subway is for. Either move farther away and spend on transportation or stay where you are and cut it. Don’t do BOTH.

Also, $469 a month for life insurance? If you sell the house and get passive income from a portfolio, you won’t need life insurance because your portfolio IS your life insurance. So that gets rid of the $469/month.

If you can cash in on the houses, and move to a less expensive area (I’m seeing 3 bedroom homes for rentals for $1900/month in Mississauga—near the airport) or downsize to a smaller house, that would cut $3800/month or $45,600/year, dropping your yearly costs from $115,641.72 to $70,041.72.

Drop the transportation costs by going down to 1 car, and you could save another $11,286/year. Replace the insurance with the portfolio, and save another $5628. Now, we’re looking at $70,041.72 – $11,286 – $5628 = $53,128! This would raise your savings rate from 12% all the way to 59%.

Now let’s combine that with the money you’d raise selling sell your properties. All of a sudden, you’d have $1.2 Million!

This brings your TTR down to:

Year Starting Balance Annual Contribution Return Total
1 1,200,000.00 77,972.00 72,000.00 1,349,972.00

Holy crap. You’d be done in 1 year!

This one’s a no brainer guys. Would you rather keep spewing money, freak out about the housing market and be 1 Million in debt? Or cash out now, downsize to a lower cost area and be retired in a year? I know which one I’d choose.

What do you guys think? Chime in below!



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53 thoughts on “Friday Reader Case: Would You Rather Have One Million in Debt or One Million in Assets?”

  1. I am no math wizard, but I think the stress factor and measly monthly cash flow strongly argue in favour of selling at least one of the properties. Possible unemployment stresses me out greatly and I don’t even have debt to service. Do your mental health and marriage a favour and sell at least one. The kids will get used to a new house.

    1. I’m with you, CanadianLawyer. Possible unemployment should stress out most people–especially with debt. They have a winning handing if they sell–hopefully they don’t sit on it until it turns into a losing one.

    1. As a Canadian, you’re tax-exempt only for your live-in property. They would have to pay capital gains for the “investment” property.

      1. Wow that is a huge tax advantage! I am sitting on $2M in gains for my live-in property in the US, tough to sell.

        1. Don’t forget that we don’t get to deduct our mortgage interest from our taxes.
          So, it appears the US looks at buying a house like a business – you can deduct the interest like in a business loan, but you pay capital gains tax as if you made income upon selling.
          In Canada we treat our primary residence like normal consumption – you pay with your full after tax dollars and it’s just an item you own, not considered an income generator upon selling.
          The Canadian approach makes more sense to me when dealing with our primary residence – it is a lifestyle purchase after all.

  2. CanadianLawyer is absolutely right — kids are super adaptive, and seem to key off parents’ feelings an awful lot… so treat it as an exciting new adventure rather than a frightful uncertain future.

    Man, I wish I had this “problem”. I’d sprain my finger pulling the FIRE trigger.

  3. Wow, this one seemed pretty obvious! A perfect example of people overleveraging themselves into real estate “because it’s a good investment”.

    The reality is they’re mortgaged to the hilt and not seeing good returns on the properties. Any tiny little economic blip that results in a job loss will have them in the poorhouse.

    I’m with you FIRECracker — they need to sell at least one property.

    1. “Any tiny little economic blip that results in a job loss will have them in the poorhouse.”

      That’s exactly it, Mr. Tako. Gotta think about the downside, not just the upside. At least for us, when the market plummets, we live our sweet sweet dividends. In this case, there’s no where to run when the housing market plummets.

  4. Myyy…loved it FC. Again you killed everyone who things buying a house is a good deal. It just buries you alive in debt!!!
    I wish I had this problem. I’d be selling both properties and FIREing today and live the good life!!!!

    1. Yeah, it’s a no brainer 🙂 Sell and live an awesome life or be in a debt and stressed. Not exactly a hard choice.

  5. I love real estate but in this case there is no balance whatsoever, they need to sell at least one if not both!
    I don’t get the transportation cost! That’s huge!
    And lastly, the only thing I don’t agree with is that with two young kids, they may not want to eliminate the life insurance entirely. Piece of mind is really important too!

    1. Agreed for the insurance for peace of mind with kids but it’s probably so crazy expensive because they are doing whole life or something that offers “benefits” they don’t need/understand/isn’t really a benefit instead of term insurance which is way cheaper! We are a little older and pay about 10% of that!

      And their car expenses are crazy high!! Hello transit!

      1. Agree, Michelle. Even if they want to keep the life insurance, pick a better plan. Why pay so much to get extras you don’t need?

        “Hello transit!” is what I thought too. Get rid of one of the cars!

    2. I’m getting lots of consensus from renters AND owners on selling. Looks like it’s gotta go!

      I don’t get the transportation costs either. They’ve gotta be leasing 2 cars–otherwise, the number makes no sense.

  6. Sell both and rent in an area that’s relatively close to work & school district (atleast within biking distance) & you’re all set. Maybe after you reach you FI number both can retire or atleast one of the parent to focus on the children if they want to

    1. So true, Sageybadegey! They have a winning hand that could turn into a losing hand if they wait too long. If if they don’t both retire, at least one can stay home and focus on the kids.

  7. Spending that kind of money on a car lease sure seems like a waste when one car is just spending a good amount of time sitting in parking at Pearson, and only going to work a couple of times per week. Flight attendants really don’t need to do a lot of mileage for work unless they live very far from the airport, and with that kind of mortgage debt, I would sure hope that they could live close to work.

    I drive about 5,000 km per year with my airport car, and that includes using it for non-work stuff.

    1. “with that kind of mortgage debt, I would sure hope that they could live close to work.”

      This is exactly what I was thinking. Either spend on transportation and cut housing costs or vice versa. Don’t do BOTH!

      You only drove 5000km for the entire year? Nice. Do you work for an airline?

      1. Yes, I do the same job for the same airline as the case subject, so I have a pretty good idea of the amount of travel to work is required; it’s considerably less than a normal 9 to 5, and the car ends up spending a good amount of its time sitting in airport parking, which isn’t necessarily great for the body, given the careless employees coming and going.

        I drive 5,000 km/year in my airport car, although I admit I have a “fun” car with which I do road trips and general “I feel like driving” wastefulness in the summer. I count that one under “hobbies” in my budget, and I average about 2,000-3,000 km per year in it. Before I had the airport car, I took the bus to work for 5 years (although only for a few months while based in Toronto), and honestly it worked just fine, even if I enjoy the luxury of taking a car now.

  8. At the very least I would sell one of them (preferably the 1.45 million dollar house). Having $1 million in debt would probably make my heart stop.

  9. Hey! First time commenter, but I’ve been lurking for awhile and your blog helped me figure out what my husband and I wanted to do with our finances once we finished paying down all of my student debt, so thank you! (I was starting to get house horny and you helped clarify that, if we do ever buy a house in the future, it’ll be AFTER we’re FI and it’s NOT an investment).

    With regards to Scared in GTA, I actually have a compromise position to suggest – why not sell the rental with the bad cash flow and use the $355,500 to pay down the primary home’s mortgage? Now, this would in no way make them financially independent and it’s a strictly worse position if you’re just looking at the math. However, if SiGTA is that attached to the house and neighborhood, it would at the very least put them in a much better position in terms of just how much debt they’re carrying, when that 5-year refinance comes around. $225k vs. nearly a million – granted, if both of them were to lose their jobs, it could still crush them, but they could also snowball their payments until their next refinance too, to try to get that balance even lower or paid off completely, leaving them with annual housing costs of about $7k per year in the future.

    The reason I’m even suggesting this is because I’m wondering if SiGTA would do any better right now if the stock market were to correct. Look at her language when she says;

    “We now have a buyer that is ready to present an offer. The thing is the offer will probably look like something that was sold in dec 2017. That means $300k less than back in feb 2017. I know that we can’t look back but still we can’t help but at least compare.”

    Will having $1.1 million in an index fund really help her, if she’s looking at that index fund and sees it drop to $800k and can’t help but compare? If SiGTA is confident she could look at that and not sell, then go ahead, sell the properties and rent – it’s absolutely the better mathematical choice. But, unless we hear otherwise from her, there’s a possibility that she’s more comfortable with housing correction than market corrections – at the very least, she’s watched the house’s potential price drop $300k and she’s still reluctant to sell, due to simply liking where she lives.

    Basically, if she and her husband want to keep the primary residence for whatever reason, then they’re at the beginning of their FI journey, not the end.

    1. Thanks for your 2 cents, RJ! I especially love this “if we do ever buy a house in the future, it’ll be AFTER we’re FI and it’s NOT an investment”.

      As for paying down the mortgage of the first house, while that might make help them feel better, it doesn’t help to diversify their assets. They would end up putting everything they have in one over-valued asset. You’re right, a portfolio would fall during a bear market, BUT they’d still get paid dividends, whereas the house would continue costing them money as it falls. They can also liquidate part of the portfolio to cover living costs, but the house is all or nothing. I’d much rather have a diversified portfolio (remember that it wouldn’t be 100% equity and the fixed income part would help smooth out the ride) when markets are tanking than a house I can’t sell and still continues to cost me money.

      I think if the house were less expensive and their mortgage was paid off, then it wouldn’t be a big deal. But to have 100% of their net worth in a million dollar house–that’s a TON of risk.

      1. Fair enough, as regards the level of risk in having everything in the one asset class. I hope SiGTA drops back in eventually and lets us know what they decided to do. 😀

      2. Don’t forget that even if they are 100% in equities, they can “buy into the storm” if the market tanks. They can keep buying more shares at lower prices, getting more bang for their buck.

        You can’t do that with physical real estate. If home prices crash, you can’t just “buy more house” and have a second kitchen spring up in your backyard. Maybe in a RTS (Real Time Strategy) video game, but not here.

        Sincerely,
        ARB–Angry Retail Banker

  10. To play devil’s advocate a bit – OP seems to indicate that they would spend pretty much the same amount on rent as they do on the current mortgage if they sell. If that’s true, then they are better off keeping the house. At least they are building equity as the mortgage reduces over time and the property (most likely) increases in value.

    Also, if people are knocking on the door with offers, don’t just take the first one that sounds halfway decent – list it with a good agent and get top dollar!

    Regarding the rental, I might be tempted to keep it. Sure they are just breaking even pretty much so it’s not a stellar investment. But you’re completely discounting the appreciation on the property and the monthly decrease in the mortgage balance that the tenants are paying for them. So the return is MUCH greater than 0.5% or $150 a month. Then again, if they aren’t counting ALL deferred maintenance and expenses in the calculation (meaning their cash flow is probably actually negative) then dump that thing.

    1. When it comes to investing, diversification is important. Assuming houses will always go up, and sticking everything into one asset is EXTREMELY risky. I don’t expect the stock market to go up forever, home owners shouldn’t expect the housing market to go up forever either. Also, even if the house appreciates, you still have to CASH OUT at some point. If you’re renting it out and getting a cashflow of only 0.5% return, your investment is all stuck in the house and you can’t ever get it out until you sell.

    2. I think the point is they are way over leveraged in Real Estate, all eggs in one basket, and stuck to service the debt on both properties. And combined with other ridiculous expenses?

      cars, life insurance? (Universal Life Policy ?) the paycheck is spewing out the door.

      you can move assets around in a Balanced Portfolio, can’t do that when its all tied up in debt in 2 properties. And yes, we are at the top of a housing bubble, and probably an Equity bubble as well, so its time to diversify.

      cheers

  11. So the 5762$ Expense in housing, does this include the rental cost? And does the 10925 include the rental income? Otherwise how on earth are they spending 5762$ a month? Also if someone knocked on her door to buy, are there any realtor fees to pay? Transportation expenses are outrageous, life insurance fees at their age are crazy. What kind of policy would cost that much?
    So I think sigta is attached to rental property not because of the cash flow but because they have likely seen historic increases in property value. And I get that mindset. However as a rental investment you should be doing soooooo much better. Your rental property is over 50% owned and you are positive cash flow $150. Sell it. I calculated what I am getting after operating expenses, on approximately every 390,000 I have invested in real estate, it’s 2900$.
    I also agree that the principle property should be sold and invested. So rent costs the same as your house carrying costs, but investing the proceeds from the sale of your property would more than pay your rent in same area. So in my opinion you could be in a great situation by selling.
    You could also sell your main residence and enjoy the principle residence exemption, then move into your rental…….if you wish to avoid paying capital gains when and if you choose to sell the rental.

    1. $5762 is for their primary residence (the 1.5 Million property), not the rental property. The cost is high because of the mortgage, maintenance, property taxes, and insurance.

      Good point on moving into the rental to avoid the capital gains tax–I forgot to mention that.

      Thanks for the tips on the rental property, Suzq400!

      1. 5762 on a 680,000 mortgage is some insane home spending. A money pit. A mortgage on that amount should be 3000-3500 but hopefully much lower since they should be locked in at a historic low interest rate sine they have owned a while. 510 tax, they may again have ridiculous insurance, outrageous utility bills? Home has had major repairs? Any other home owners think this is nuts?

  12. It is interesting how differently we look at the rental properties! This is actually the path we have taken in our retirement path. We buy properties with cash, increase their value (in case we want to resell at some point), and we rent them with 6.5-6.7% net revenue.

    We have diversified our portfolio, from having all of the properties in Kraków, Poland, and bought a house in the US, cash also, that gives us 4.2% net, plus we also increased the properties value since purchase.

    We invest in markets with heave lacks of properties for rent. We never needed to wait more than to beginning of next month to rent.

    Overall, we average above 4%, and we won’t need to sell them to get our retirement paycheck.

    But: I would NEVER go into it if I had to take a mortgage!

    1. If you’re diversified and you’ve got cashflow from the rental properties, great, I’m happy it’s working out for you!

      Maybe you can give SIGTA some tips about real-estate investing…

    2. If you had cash, and bought when the US market crashed, you are laughing now. Even Warren Buffet said he regretted not going out and buying a few dozen homes and holding them. He saw the value.

      So where is the Value in Real Estate today? Is there one?

  13. You forgot to add the mortgage repayments into monthly profit on rental property. It will add to the percentage you calculate. Also one should invest in something he knows, not everyone knows where you take your risk-free 4+% from.

    I don’t understand what they spent money on under the housing category. $5762-mortgage is $5000. What do they do with it? Electricity, heating, internet and Netflix? Surely it’s not $5k?!

    1. When it comes to early retirement, mortgage repayments don’t help. You need CASHFLOW to live on. If the equity is stuck in the house, it won’t help them until they sell.

      $5762 includes mortgage, property tax, maintenance and insurance.

        1. I’m in canada, and I have no idea why that number is so high. $ 5762 is ridiculous. Even including phone cable internet tax and utilities and insurance unless it is including major repairs?? Maybe sigta will write in to clarify. I actually thought it must include both mortgages!

  14. Hi, late to the party here.

    I’m siding with FC middle-ground suggestion of ditching the rental only and investing the money, using the dividends to help pay for life a little bit.

    The reason I think it is a good solution for SiGTA is that we tend to assume on this blog that everyone want’s to retire early and become a digital nomad, but this isn’t often the case. It sounds like SiGTA wants to give a stable environment for her children to grow at – meaning a house they can call their own, trees they can carve their name on, childhood memories of knowing every shortcut in the neighborhood, every basement of their friends etc. You just don’t get that as a renter. I am a renter with kids, I know how it feels… I am extremely happy to be debt free and have reasonable portfolio, but there is a cost to everything in life – the cost of being a renter is emotional when it comes to raising kids in a rental.
    (By the way, thinking of it now, as a kid we did move to a rental for a few years. I don’t recall ever caring that it wasn’t our house. Kids really are very adaptable!)

    Additionally, much like what RJ mentioned, SiGTA may not have the right investing psychology to jump all they way from from a house-owner to a live-on-my-portfolio in one swoop move of selling both properties and constructing an income-generating portfolio. It is too much of a jump.
    Even for FC (based on your own blog posts) it took years of building savings in the hope of buying a house, and then years of investing and slowly seeing the portfolio grow and generate income, before you were ready. going from one extreme to the other is too much.

    So – I think that selling the rental and learning to constructs a portfolio, seeing it grow, and seeing the income it can generate passively will be a good learning excercise for SiGTA. At the same time, she can stay in her neighborhood that she loves and give her kids the life she wants to. If at some point she finds that she likes the passive income from the portfolio she can always sell later. In fact, when the kids are older, have moved out, and it is time for thinking about downsizing, she will be mentally prepared to sell and live of her portfolio thanks to having the small one she built from selling the rental.

    SiGTA still needs to figure what to do with her car and insurance expenses. We have 2 life insurances, one is a full on disability and income coverage in case of injury, for less than half of theirs, and we have 2 cars which combined are less than half of their expense. Not sure why they spend so much.

    hopefully SiGTA will chime in at some point with her thoughts about our comments and what she decides to do.

    1. “as a kid we did move to a rental for a few years. I don’t recall ever caring that it wasn’t our house. Kids really are very adaptable!

      That was me as a kid 🙂 I think people underestimate just how adaptable kids really are. They just want to spend time with you, they won’t care whether it’s a rental or not.

      She could keep the primary residence and sell the rental–however, as Suzq400 mentioned they’d have to move into the house for a period of time to make it their primary residence, otherwise they’ll get hit with capital gains tax since it’s a rental property.

      I’m with on the spending. There are definitely some inefficiencies there. Maybe you can give them some tips. What kind of cars do you have? How much is your life insurance?

      1. Well, if it helps SiGTA, here are our details:

        Cars: we own two cars, one new one older (not leasing, we own both). We pay 190$/month insuring both via TD insurance. We both commute to work, approx 50km per day combined. Our monthly gas averages about 250$ per month and we put aside a bit of money for maintenance each month (100$-200$). So, combined, it is about 550$/month for two cars.

        My life/disability insurance is Manulife Synergy, it’s a combined life/critical illness/disability insurance, for 122$ per month. It is an expensive policy but my work is physical and an injury can put me out of work, so we consider it an appropriate level of coverage. My wife’s life insurance policy is only about 30$/month.

        Hope that helps to give you some comparables.

        1. Thanks, NewB Investor! Those numbers are helpful. Looks like SiGTA’s transportation costs are high mainly because they are leasing 2 new cars. Probably not a bad idea to get rid of at least one, or buy used cars instead. As for the life insurance, no idea why it’s so expensive. Looking at your rates, they could probably do a lot better.

      2. My kids grew up in 4 rental houses before we bought, when they were school age, we kept them in the same elementary, and high schools, that was the key. They still remain friends with kids from the old hoods, with facebook, etc. We had a great time in all the places we rented, it was like camping, for 2 years in the same campsite, then moving on. And oh boy do you get rid of a lot of crap when you have to move… Now that I am no longer a Nomad, I am collecting a lot of crap…

  15. In my opinion, I think that the couple has the easiest decision to make in respect of the current circumstance. Liquidate these two house assets and use the proceeds to invest in the shares. etf and bonds ect. The dividends are enough to pay for their housing rentals for life. They can live their life on their own terms.

    Ben

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