Downsize and Invest the Difference
The decision to downsize your home as you close in on retirement can be a tough one. Maybe it's time for that little cottage by the water or just a smaller place where you don't have to climb stairs all day long. The question is how do you know if now is the right time? How do you know what size of property will suit you and your needs best? What should you consider when deciding between renting and buying? What should you do with the lump sum once it arrives from selling your house and downsizing into something more manageable for your needs?
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In the previous episodes of our series, we talked about what retirement will look like for you. We covered how you can create a budget, or what I like to call a mindful spending plan. We learned about the 4% rule and how it helps you figure out how much money you need to retire. Today we're going to give you some final tips before you make your move.
One big consideration in downsizing is deciding where you will live, and the cost of living in your new community. It's important for you to understand this so you can estimate how much money you'll need to save. That goes back to the 4% rule.
Deciding Where You Want to Live in Retirement
Sometimes where you live may be decided by the fact that you have grandchildren and want to live near them.
If you know you're going to have a tight budget, you may decide to move to a foreign country that's more affordable like Mexico or Bali or Ecuador. I have friends and family that live very good lives in those places.
Wherever you decide to live, besides the cost of living, you'll also want to consider a few things:
One is the cost of property taxes. Even if you're able to live mortgage free there's no getting around taxes.
Another consideration is how easy will it be to access things that are important to your joy and ease of living.
Is it really important that you be near a lot of arts and culture?
Or, is it more important for you to have easy access to hiking trails and other outside activities?
Take a look at how long it will take in your daily life to access those things that are important to you.
There will be trade offs. For example, it's easier to have food delivered to our homes but you can't deliver a forest to your front door, so think about that.
And finally, access to medical care becomes a lot more important as we age. See what hospitals are nearby and research medical clinic availability - know what to expect.
Do You Want to Rent or Buy a Home in Retirement?
Once you've decided on a location, will you rent a home or buy a home? Before we get into looking at this choice from an investment point of view, it's important to find out the vacancy rates in the area you're interested in.
I have a client who was considering renting for most of her retirement. But when we looked at the available pool of rental units, we realized there was a real risk of her not being able to stay in the area as there was such a low supply of rentals. There was a very real chance that rents would rise to a point where she couldn't afford to live there, if she could find a place to rent at all. So she found an affordable place to buy before she retired so that she could still qualify for a mortgage with her employment earnings.
Now let's take a look at the pros and cons of renting versus buying from an investment point of view.
Why Should You Rent a Home in Retirement?
Renting can be more affordable way to go, especially if you don't have the means to pay cash for a home. Renter's insurance is less expensive than homeowner's insurance. There are no property taxes or condo fees to pay if you're renting. The upkeep and maintenance is, of course, very inexpensive when renting. If your lease is up and you decide to move, you can even take a break from renting to go traveling - put your belongings in storage or sell them to finance your trip and live the gypsy life for a few months or a year.
If you have proceeds from the sale of a home before you decide to rent, you can invest the proceeds and create an income stream for yourself instead of putting the proceeds towards a down payment on a house. If you've lived in your home for a long time that lump sum can be substantial. And that alone may provide the income you need to pay for your rent.
A $300,000 lump sum is not an unreasonable amount of money to have after the sale of a home if you've owned it for a long time. That $300,000 can provide an income of $1,000 a month for perpetuity and you still have the $300,000 left for your estate after your pass.
Another benefit of investing the money instead of putting it into your home, is you're able to access emergency cash when you need it - without taking out a loan against your home.
And remember, you can consider renting in a foreign country where a comfortable $800 per month rent payment in year round sunshine is not uncommon.
So, if you live in an area with reasonable rents and a reasonable vacancy rate, renting can be a good option.
In Canada, if you can find a 5% vacancy rate, that is high enough that you'll have more choice in rentals. Anything below 2% means the rental market is tight and you risk not finding affordable housing if your landlord decides to sell or raise rents. Any local property manager can help provide you with vacancy rate averages for the area.
Why Should You Buy a Home in Retirement?
Now what are the pros of owning?
Well the big one is that hopefully, you're in an area where homes are appreciating in value.
Remember that is not always the case. There are areas of our country that have experienced large booms and busts. We have been spoiled over the past generation, but certainly we've all heard the stories of those who bought and sold at the right times and did very well.
But we all like to pour money into our homes and gardens, because we love them and want them to look nice for us, our friends and family. Because of that, I don't look at owning my home as an investment that will earn me a stream of income.
I do look at rental property, property that I buy to rent out that way. I see that as an investment that will earn me a stream of income, but not my own home. It's basically a wash in the long run.
But there's greater security in owning your own home for sure. You don't have to worry that your landlord is going to sell from under you. You don't have to worry about whether your rent payment will go up suddenly.
Now that doesn't mean your mortgage payment won't go up and property taxes are generally rising. Interest rates may rise when you go to refinance in five years, but at least you have some control over that - you can prepare for it.
You can also borrow against the equity of your home, if you need cash.
There's psychological factors too. There's pride in ownership - something you can call your own.
And if you can afford to buy a house without taking out a mortgage, you'll have more freedom to travel because the money you would have spent on mortgage or rent payments can be spent traveling the world.
What to do with a Lump Sum from the Sale of Your Home in Retirement?
That brings me to a question I often get.
If you've sold your old home, and you now have a lump sum of money, should you take out a mortgage or should you invest it? If you get an inheritance or other windfall, should you use that money to pay down your mortgage or invest it?
Well, there's an investment answer to this question and there's a psychological answer to that question so let's take a look at the investment side first.
Advantages of Investing a Lump Sum from the Sale of Your Home
The rule of thumb used to be that if your mortgage interest was greater than 5%, you should pay down your mortgage with windfall profits rather than invest.
That rationale is related to the fact that if you maintain a lower risk balanced investment portfolio you can expect to earn about 4%.
So, if you can get a mortgage for 2% and invest the rest of your money at 4%, you're earning a net of 2%.
But if your mortgage is 5%, you're losing 1%. You're paying the mortgage bank 5%. So, if you can only earn 4% on that money, you're losing 1% on the money investing.
We haven't seen mortgage rates above 5% in over 10 years so there hasn't been as much incentive to pay mortgages down. Most people have been better off taking a mortgage out at 2% and investing the money they would have used to pay cash for a house, or put a big down payment on a house, and instead they're investing that cash at 4%. Now they're earning enough money to cover their mortgage payment, and still grow their savings
Advantages of Using a Lump Sum from the Sale of your Home to Pay Down Debt
Not everyone sees this as a pure money decision and that's okay. In the minds of many of us, debt is debt and they hate it. They don't want any debt hanging over their heads. It's a personal decision.
So which option is best for you - renting or owning? You'll want to talk to a financial planner who could prepare several cash flow projections for you based on different scenarios. And that's what I do with my clients.
In the end it's a very personal decision.
Downsizing Tips Before you Retire
Now let's talk about the actual downsizing part. The act of giving or selling items that you don't need any more to someone who could use them can be the most satisfying part about embarking on a new journey.
It can also be overwhelming to start that process of culling belongings we've accumulated over decades.
I know I've been there!
But, without exception, everyone I've ever talked to who's gone through the act of downsizing felt so good to relieve themselves of goods that were only holding them down and holding them back from their new life.
Find some friends who have downsized and get some tips from them. Ask them about their experience.
My friend, Melody Oshiro is a productivity and organization consultant.
Melody can organize anything and she has that special Marie Kondo gift.
Melanie told me about a book called Downsizing the Family Home - What to Save and What to Let Go, by Marni Jameson. There's a workbook that goes with it and there is a blended family version if you're joining households with a partner. There's even audio book versions, if you're really strapped for time.
How Squatch and I Downsized
When my husband, Squatch, and I were making our final preparations to downsize and move to Vancouver Island, we chose to move in October.
So, we began to organizing what we were going to sell and giveaway in the spring before. That gave us enough time to organize everything into piles to pack, to sell, to give away, and to trash.
Then starting in June, for several weekends, Squatch would haul everything out we were going to sell on the driveway - and the haggling would begin. Every week he would bring out new merchandise just to keep things interesting.
The larger items he sold separately on Craigslist.
And the final batch he dropped off at an auction house that sold the rest for us.
Now if you don't want to spend all the time that he did, you can absolutely find an auction house or estate sales specialists to handle it all for you. But just know that you'll likely receive a fraction the value because they will do all the work.
Here is a good article I found, 100 Tips to a Better life.
This isn't just an article about downsizing. It's about really thinking about where you spend your time, your energy, and money in your life. There are some forehead slapping moments there!
For example, have you ever found yourself saying, "where's the good knife?" (I have). If you're spending time looking for the good knife, that means you have too many bad knives. Get rid of the bad knives - you hate using them anyway. Isn't that brilliant?
That goes for anything that annoys you.
Clothes? Why do I have so many black pairs of leggings? I know I only like the ones that don't sag in the seat. I will wear them until they turn to dust.
Here's another tip from the same article.
There are things that you use for a significant amount of time each day, like your bed (Hello sagging mattress) and your office chair. These are things worth investing good money in.
So, take a look at that article I hope you find some gems.
What's the Next Step for Retiring?
After you've downsized into your new home and are settled into your new community, you may find you have some cash leftover from the sale of your former home, put that cash to work for you by investing it and creating a good cash stream for yourself.
To learn about different tax efficient income streams to consider in retirement listen to our future series called "A Girl Needs Cash."
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