5 Ways to Know if It’s Time to Downsize Your Home

While individual reasons for moving into a smaller house may differ, downsizing is often an opportunity for people to save money and enjoy the lifestyle they want to live. If you’re wondering when to move, five circumstances can potentially persuade you regarding such a large decision. Let’s examine each one right now.

Your mortgage payment is greater than 28% of your gross income

Generally speaking—and as reported by many mortgage lenders—28% represents the maximum percentage of your monthly gross income you should spend on a mortgage payment. Therefore, if your gross income is $8,000 a month (for example), you shouldn’t spend more than $2,240 on your monthly mortgage: including costs associated with principal, interest, property taxes, and homeowner’s insurance.

If you find yourself above this threshold, you certainly aren’t alone. According to Harvard University’s recent “State of the Nation’s Housing” report, over 30% of households spend 30% or more of their income on housing. Even more concerning? Approximately one in seven households spend half(!) or more of their income on these costs.

As with any rule, exceptions do exist. For example, let’s say you (or your spouse) lose your job and thus only hover above the 28% threshold for a temporary period of time. Perhaps a spouse leaves a job (or cuts back on hours) to care for children or elderly parents. Either which way, if you can get by with a temporary drop in income, that’s fine. Otherwise, you might consider downsizing if you are significantly over the threshold.

You can’t keep up with home maintenance and repairs

A recent analysis conducted by Hippo, an insurance company, found that the average American spends approximately $3,000+ per year on home maintenance and repairs: expenses that naturally vary based on the location of your residence and the size/type of your home. You’ll also spend more during some years than others. That said—regardless of the amount—if you can’t afford to keep up with maintenance and repairs on your home, that’s perhaps another sign that it’s time to downsize.

As a general rule of thumb, you should set aside at least 1% of your home’s value every year for maintenance. Therefore, if your home is worth $400,000, you should save $4,000 a year (or $333.33 a month) to cover these expenses.

Alternatively, another approach is to sock away 10% of the total cost of your mortgage payment (which includes property taxes and homeowner’s insurance). Therefore, if your mortgage costs you $3,000 a month, you should save $300 for maintenance and repairs on a monthly basis.

If home repairs are sinking you further into debt or you’re unable to save for future maintenance costs, downsizing may make the most sense.

You can’t enjoy the lifestyle you want to live

The decision to downsize also heavily involves your goals and desires. Want to pay off more debt? Save more money for retirement? Dine out or take vacations with friends more frequently? If you struggle to enjoy the lifestyle you want to live now (or in the future) because your home expenses are too high, downsizing may be a top option.

Move.org estimates that a typical U.S. family spends almost $300 a month on essential utilities such as electric, gas, and water. Downsizing to a smaller home may not only help you save on these costs, but you’ll likely also benefit from lower property taxes and homeowner’s insurance fees that often accompany a smaller place—meaning you can dedicate more of your money to “fun” expenses like dinners out and trips abroad.

You don’t need that much space

If you’re no longer using the space you’re paying for (e.g., multiple bedrooms), you’ll definitely want to consider downsizing. This scenario is prevalent among empty-nesters; perhaps they needed the extra square footage at one point in their lives, but this is no longer the case. If this applies to you, downsizing makes complete sense.

Your house has appreciated considerably

While nobody can predict how the housing market will perform in the coming months, it might make sense to take advantage of a rise in your home’s value. Then again, it’s impossible to time the market perfectly and you’ll need to find another place to live: which means you may buy at a premium price as well. One possible option to avoid this? Sell, rent for a while, and then buy once the housing market cools again.

Considerations prior to downsizing

Properly assess the value of your current home
You can take several approaches to determine your home’s value. While an online estimator can give you results in mere minutes, the corresponding accuracy isn’t always the best. For example, Zillow admits to an almost-8% median error rate for off-market homes that can over or underestimate the value of your home. Therefore, it’s safe to assume—especially in areas outside of large cities where the turnover rate is lower—that the margin of error is pretty significant for these tools.

Thankfully, local real estate agents can provide you with a more accurate appraisal: considering the assessed value, comparative sales, and any home features and upgrades an online algorithm cannot. You can also ask your realtor for strategies to maximize the value of your home. Nevertheless, an even better option is to hire a professional appraiser. Although this will cost you a few hundred dollars, he or she will make sure to consider each and every property feature that impacts value.

Understand all costs associated with a home sale
After you obtain a realistic home value estimate, you’ll need to assess costs attached to selling your home: including closing costs and taxes. Following the home inspection, a buyer can request modifications or repairs. Thus, with the exception of cosmetic changes or upgrades, the seller may be on the hook for items such as pest damage or electrical, plumbing, roof, or foundation issues.

Closing costs—which, according to Bankrate.com, can range anywhere from 2% to 7% of a home’s sale price—can include payment for the mortgage balance, property transfer taxes, recording fees, and attorney costs. You’ll also need to pay any real estate commissions at closing, ringing in at up to 6% of the home’s sale price.

It’s also important to understand tax implications, knowing that Uncle Sam allows most couples to exclude up to $500,000 in gains from their taxable income (depending on how long they’ve lived in the home).

In sum: when to downsize your home

Downsizing your home is both a financial and emotional decision, especially if you’ve lived there for years and created many memories within its walls. If you find that your current income (or projected income, if you’re nearing retirement) can’t sustain your expenses or is preventing you from living your desired lifestyle, downsizing is perhaps a viable option.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.