Downsizing to a smaller home — typically when you reach your sunset years — comes with several benefits. The big one? Owning a smaller home can provide financial relief.
Your new, smaller home might come with a smaller price tag, which equates to a lower monthly mortgage payment and can help with an estate plan. At the same time, smaller homes typically come with lower property tax and insurance bills. Owning a smaller home might also mean lower maintenance costs and less expensive utility bills.
Then there is maintenance. A smaller home might mean less time spent mowing your lawn, weeding your garden, shoveling snow and raking leaves. Depending on the type of home you buy, such as a condominium or residence in a community governed by a homeowners association, you might not need to worry about any yard work.
This isn't to say that downsizing doesn't come without negatives. You might find yourself with too little space after moving to a smaller home. You might miss that outdoor work. And the savings from downsizing might not be as much as you expected.
But if you are ready to downsize, you have options, depending on how much equity you've built in your current home.
What is equity?
Equity is the difference between what you owe on your mortgage and what your home is currently worth. Say your home is worth $400,000 and you owe $100,000 on your mortgage. You have $300,000 in equity.
The more equity you have, the greater your profit when you sell and the easier it will be to purchase your new, smaller home.
Say you sell your home for $425,000. If you owe $125,000 on your mortgage, you'll end up with $300,000 after the sale. Of course, you won't take that full $300,000. You'll have to pay your real estate agent and any seller closing costs associated with the sale. You might instead leave the closing table with, say, $270,000.
You can then use that $270,000 to purchase your new, smaller home. Depending on where you live, you might be able to pay all cash for your next residence. If you live or are moving to a more expensive part of the country, $270,000 might not be enough to fully cover your new home's price tag, even if you are downsizing. But it might be a good enough chunk of money you'll be left with for a far smaller mortgage, and lower mortgage payment, after you move.
Of course, you might prefer investing the profit from your home sale in the stock market or other investment vehicles instead of using it to buy your new residence. This might make sense if mortgage interest rates are low. You might generate more money by investing the proceeds from your home sale than you would save by avoiding interest on a mortgage loan.
Debating whether you are ready to downsize? Wondering whether you've built enough equity to make downsizing an easier financial move? Work with an accountant, an estate planning attorney and/or a real estate professional to help you decide.
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