Downsizing your home in retirement sounds like a great financial move to make. “Great! I’ll have a smaller mortgage!” you may be saying.
The mortgage is only one piece of the pie. If you are retired or close to it, all of the financial implications of buying a new home should be considered, as they do add up. Ask yourself these questions to get a sense of the total cost of home ownership you are entering into by downsizing your home in retirement.
#1 What are the one-time costs I will have to pay in cash?
Don’t forget about the one-time cash outlay you will have to make when buying a new home. Closing costs may include but are not limited to:
- Mortgage origination fee
- Attorney
- Bank attorney
- Buyer and selling agent commissions (3% for each)
- Inspection
- Building search
- Government recording fees
- Miscellaneous title fees
- Convenience fee for loan payments made by debit card
- Appraisal fees
- Mortgage subordination fee
- Assignment of mortgage to non-investor bank/third party
- Real property tax service fee
- Servicing request to transfer title of property to LLC
- Release of Borrower Fee
- Spreader Agreement
- Partial Release of Mortgaged Premises
- Real Estate Tax Adjustment
- Tax escrow
- Lenders policy title insurance
- Tile insurance fees
- Prepaid interest fee
- Landlords insurance
- Depreciation expense for major repairs
- Vacancy expense
- Property survey
- Application fee
- Water quality certification
- Land transfer tax
- Local Improvement Charges
- Earnest money
This varies by location and the type of property you are buying. Get clarity on all these expenses before signing the contract. If you need to talk to a financial advisor to create a one-time analysis, we can help you – please contact us here.
#2 How does my cash flow change on an ongoing basis?
Just because you are downsizing to a smaller home, it doesn’t mean your total cost of homeownership will be lower. After you get the deal done and you move in, your cash flow may change. Consider the ongoing costs you’ll pay, before you sign the contract.
Rehab and maintenance costs
Does the property require any renovations? How old is the roof? A smaller home with high maintenance or rehab costs may cost you more than a bigger home.
Mortgage costs due to market dynamics
Downsizing a home might not necessarily be the best thing for your cash flow. Let’s say you owned a 2,000 square foot home for 25 years. You bought it for $80,000 and now it is worth much more. In today’s market, home prices are high and interest rates are high. Buying a property half the size may run you the same monthly mortgage fee.
Property tax changes
Property taxes are ongoing and they can change as the conditions in the municipality evolve over time. For example, property taxes may rise if there is an increase in development in the area, necessitating infrastructure upgrades. While this can’t be predicted, it is useful to consider how likely these changes are to occur and what your plan would be to afford higher taxes.
HOA fees
Homeowners Association Fees can increase and if you own the property, you have no choice but to pay them. What has been the history of fee increases with this particular HOA? Get a copy of the minutes and see how disputes are resolved. You don’t want to be at their mercy.
Much like closing costs, all of this should be included in your financial plan. As part of our wealth management services, we can put together an analysis that will present you with a projection of the ongoing housing costs you’ll bear as a result of this change.
#3 What are the capital gains implications?
If you have a large, unrealized gain on your home, downsizing may mean a hefty tax bill. If you plan to pass the home to your children at your passing, the cost basis steps up to market value without any tax being paid. Ask your CPA what the tax impact will be of selling the home outright, if that is your plan.
#4 Can I do a 1031 exchange?
A 1031 exchange is when you exchange one property for another one. This helps to defer the capital gains taxes you pay. There are many specific conditions that be met, but it’s a good idea to ask your CPA or financial advisor about it.
#5 What are the financial implications of a loved one inheriting this residence?
These questions are painful to think about but it’s best for everyone if you can put some thought into these topics. The home you are moving into may be the final home you own. Have you done the financial planning for the next owner, the loved one who is going to own the home after you pass?
Ask yourself these questions.
- Will my spouse/children be able to afford the time and expense of maintaining this property?
- Have I done end of life planning to help my survivors to afford the cost of my final arrangements in the midst of coordinating a property transition?
- Are the legal and financial documents readily accessible to my survivors?
- Are the location and features of this property going to be amenable to the lifestyle needs of whoever inherits it?
Retirement should be a time of comfort and joy. Making the right decision when downsizing into a smaller home is crucial at this time.
We are financial advisors serving families in Manassas, Virginia, and the surrounding area. Being long -time residents of this area, we can help advise you through your housing decisions and beyond. If you would like to meet with us, please set up a time to speak.
