Traditionally, downsizing from a larger home has been a strategic move for retirees looking to simplify their lives and bolster their savings. However, with the current housing market and interest rates, the equation has been altered.
Downsizing basics
Downsizing is a natural step for many in retirement due to a plethora of advantages. For one, downsizing is a great way to unlock the equity in your larger home by buying a smaller home. The difference in price can be used to support living expenses in retirement, and smaller homes can typically lower other costs of living such as utility bills and maintenance costs. Some may downsize because they no longer require as many bedrooms now that they’re empty nesters. For others, it’s because they want to travel more and worry less about the costs and time to maintain a larger home. Or perhaps retiring by the ocean has always been the dream, so it’s a matter of relocation. Whatever the reason, it has been a natural cycle for retirees and that turnover increases inventory for the next generation looking to buy a home.
Historical housing trends versus today
The housing market has typically followed a pattern: A younger generation moves into the market to buy their first home, the generation above them looks to upgrade their first home to a larger one, and the generation of retirees looks to downsize. In theory, it works perfectly – the retirees sell to the generation below them who are looking to upgrade, and they sell to the next generation of first-time homebuyers. The financial cycle lines up with that pattern nicely too, as retirees look to lock in some of their equity to support them in retirement, and so on.
However, higher interest rates have significantly impacted this cycle. The “middle” generation holding on to their smaller homes with 3% mortgages because upgrading to a more expensive house at a 7% mortgage rate is not the incremental step it used to be. As a result, these smaller houses aren’t turning over and being added to available inventory. So, you have the first-time homebuyers and downsizers competing for a limited number of homes. The number of homes for sale between 750 and 1,750 square feet has dropped 41% in 2019, and prices for these homes are 50% higher than they were before Covid. And for those wanting to downsize with an existing mortgage, moving to a smaller home might translate into a bigger monthly payment.
Paths forward in a difficult market
The good news is that while all of this sounds pretty bad on paper, there are still ways to profitably downsize. While soaring housing prices have made smaller homes more expensive, that price trend is seen on the sell side as well. If you net enough on the sale of your home to eliminate or minimize the need for a mortgage, then you’re able to mitigate the impact of higher interest rates and still have the numbers on your side. You may need to consider factors like location, home improvement and amenities to ensure the numbers still work, but in many cases, if not in most, downsizing will lead to a boost in one’s finances.
All this said, downsizing is a significant life change that goes beyond financial considerations. It can be about simplifying your life, reducing stress, being closer to loved ones, and many other items that may outweigh the financial considerations. The decision to downsize is a personal one that can offer increased freedom, but considering the financial implications remains important. If you’re unsure about the best path forward, consulting with a financial advisor can provide valuable guidance and help you make informed decisions.