Many people blame the baby boomers for the housing shortage in the real estate market. According to stats, baby boomers hold the biggest share of real estate wealth in the U.S. And they do not sell their homes as they grow older.
Recently I have learned that there is approximately $8 trillion worth of home equity locked up in older people’s homes.
Housing experts agree that the baby boomers’ generation is healthier than the previous generations. That is why they do not need to move in with their kids or to a nursing home. Also, they do not want to move because they want to age in place. Most of them like their neighborhoods and their friends.
But with skyrocketing home prices, some people think that now is a good time to sell and downsize your home before the real estate market starts cooling off.
Downsizing can be the right path for many baby boomers who want to cash out their biggest asset and live out their golden years with more money in the bank.
Everyone likes the idea of making a profit by selling a big house and buying a small one. But be careful with this decision because today’s market might present some challenges.
High home prices, low inventory
For a long time, downsizing has been associated with empty nesters living in a big house with no kids.
A popular retirement planning approach is to sell a big house you raised your kids in and then go and buy a smaller less expensive house. The best part of this approach is that you can use all your home equity you accumulated over the years to pay for your life in retirement.
But in recent years, the concept of a smaller house has captured our society. Downsizing has become more attractive for many financial reasons.
- Less space means less money, less maintenance, and less hassle overall. And the smaller space the easier it is to furnish and decorate. Also, you can spend the saved money on something more important such as travel, hobbies, and time with the family.
After all, a smaller space has more value not only for your wallet but for your lifestyle.
However, with inflated home prices downsizing is not as affordable or profitable as it was before. If you think about cashing in on your home’s equity and downsizing to something smaller and cheaper, you might meet some challenges.
If you decide to sell now, you will be selling at the top of the market with high home prices and low inventory. But on the flip side, you are going to spend more money for your next purchase even something smaller.
When downsizing you will be looking at the smaller homes with modest square footage. Keep in mind that there are a lot of buyers competing for this kind of purchase. Smaller homes, condos, and townhouses became very popular lately and that often leads to steep bidding wars.
In many cases that smaller home you want to buy may end up being more expensive than you have originally planned.
When you sell and downsize your home do not forget about other expenses such as real estate agent fees, attorney fees, real estate, and capital gain taxes.
- Prepare to pay 5 to 6 percent of the purchase price to cover realtor agent fees, which are typically paid by the seller. Add to that an extra 2 to 4 percent of the price to cover attorney fees, transfer taxes, and other expenses called ‘closing costs’.
So, if you sell your home for $750,000, you could end up paying $37,500 in realtor fees and $15,000 minimum in closing costs. Total of $52,500 just to sell your house.
- Capital gains tax is another costly part of selling your home. Per IRS rules you do not need to pay capital gains taxes on the sale of your home if the profit is less than $250,000 (for an individual) or less than $500,000 (for a couple). But if your sales proceeds are higher than these numbers you will owe to IRS as much as a 20 percent capital gains tax on the profits.
If you live in a state where homes have appreciated in value significantly over the years, it might cost you a lot in capital gains taxes. For example, after selling your home for $750,000, you will pay to IRS $50,000 capital gains tax on a $250,000 profit.
High mortgage rates
Mortgage rates have increased more than 2.5 percent since the beginning of this year. And if you are planning to finance your new home it will be significantly more expensive than it was a few months ago.
- According to Freddie Mac, today’s average mortgage rate is 5.78 percent on a 30-year loan. By comparison, in 2021 a 30-year fixed rate mortgage was only 2.93 percent.
If you have a mortgage on your current home with a low-interest rate and looking to downsize and borrow money for your next home, keep in mind that the rate you can get will be much higher than your existing one.
Unless you want to pay cash for your new home, downsizing might not be worth it financially if you want to apply for a new mortgage.
If you are retired and live on a fixed income, downsizing will give you some significant savings down the road. But you have to compare it with how much interest you will pay over the time of the loan.
- With the average interest rate of 5.78 percent on a 30-year loan, you will pay around $443,000 in interest costs on a $400,000 home.
Also, qualifying for a mortgage might be a problem if you are not working. Keep in mind that most of the mortgages are issued and approved based on your income and not on your assets. If you are not working, it will be harder to get financing because you cannot show the constant stream of your income.
Moving cost is growing
We all know that moving is stressful. Sorting through your belongings, packing, and cleaning can be overwhelming. And with high inflation and high gas prices, your moving costs will be expensive.
- According to the latest report from the Bureau of Labor Statistics, the annual inflation rate in May 2022 was 8.6 percent. It is the highest level since 1981 as measured by the consumer price index.
In today’s world everything involved in a move will cost you more – movers, truck rentals, supplies, storage, etc. In addition to downsizing your home, you will need to downsize and replace your furniture – replacing a big sofa and club chairs with a smaller couch, a king-size bed with a queen-size bed, or a big dining table with a smaller kitchen-size set.
Do you still want to sell and downsize in today’s market?
There are still many financial reasons to sell and downsize in today’s market. And if you are getting closer to retirement, downsizing can come with lots of benefits.
If you are ready to sell on the top of the market and do not want to wait for the interest rates to settle because you will be paying cash for your next purchase, then go for it. Even with the high-interest rates but low inventory, sellers are still demanding a premium for their homes.
For example, you carry a $100,000 mortgage. If you want to sell your home for $600,000, then downsize to a $350,000 smaller home or condo, you might walk away with a nice profit.
Also, you can buy your next smaller home with cash, without having to take out a mortgage.
- You still have to carefully evaluate the market where you buy your smaller home. Look at home prices, the number of listings, competition, and how long most houses sit on the market.
Downsizing your home can help you save a lot of money on housing costs. Today, rising property taxes are a result of higher home values. If you downsize from a $600,000 home to a $350,000 home in the same neighborhood, you will pay fewer taxes overall.
With a smaller home, you will also spend less money on maintenance and repairs, heating and cooling, home improvement, and decorations.
- How to Use Home Equity in Retirement?
- 5 Tips on How to Downsize for Retirement
- Should I Pay Off a Mortgage Before Retirement?
Other alternatives to downsizing
If you do not want to sell in today’s market, there are other alternatives to downsizing if you want to wait for interest rates to settle, and housing inventory to increase in the next few years.
Once you are retired, you can rent your home and move to a rental. It will allow you to avoid the high home prices and high mortgage rates today’s market comes with.
- Also, if you need extra cash but do not want to sell your home, you can apply for home equity loans, HELOCs, or consider a reverse mortgage.
There are still many people who would prefer to stay in their homes and retire in place. They want to remain in their neighborhood for life. In this case, homeownership might provide several options to fund your retirement without the risk of stock market investments.
- One of the options is a reverse mortgage.
If your home has gained a lot in value, it makes sense to calculate the numbers first to see if it might be cheaper to stay put and take out a reverse mortgage.
Your home will continue to appreciate in value. And by staying put you will avoid paying capital gains tax completely. With taking out a reverse mortgage, you will be able to get the cash out to pay for your living expenses in retirement.
- ‘A reverse mortgage is a loan available to homeowners, 62 years or older that allows them to convert part of the equity in their homes in cash’.
In simple words, as an older homeowner, you will be allowed to borrow money against the value of your current home.
What are your thoughts on selling your home in today’s market? Share your ideas with us in the comments below.
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