Thinking about downsizing?
Your home. When you first started out, that cozy place you bought was all you needed. Then along came children, more bedrooms and a backyard. Now, the kids are grown and gone and those bedrooms sit empty. And in the process, you've likely built significant equity over the years. Is it time to downsize?
The decision to trade in your family-sized residence for something smaller is a major step, for both your lifestyle and your finances. Do your homework first so your dream doesn't turn into disappointment.
Sizing up your profits
With the powerful rise in home prices in recent years, if you're a long-time resident of Greater Vancouver, your house might now represent the majority of your net worth. Downsizing is an opportunity to unlock home equity to generate retirement income, pay down debt, help out family members or simply enjoy life.
A smaller residence can mean lower maintenance costs, property taxes and utility bills. And there could be other savings such as selling your second car if you're moving to the heart of the city with everything nearby.
If the price difference between the larger house you're selling and a smaller home is substantial, it won't be hard to make your move work financially.
But what if the price difference between your current home and the one you want is more modest, say $100,000? On the surface that might still seem like a tidy profit, but here are a few important factors to consider in your final tally.
1. The sale price you have in mind is unrealistic. Real estate prices can heat up or cool off quickly. Gauging the value of your house based on what your neighbour's sold for last fall or your latest property assessment can lead you to overestimate what your home is worth today. An experienced realtor who knows the recent sales activity in your neighbourhood can give you a more accurate view of what your house is actually worth – not just what you're hoping it's worth.
2. You fail to factor in all the costs of changing homes. Buying and selling a home generates a variety of extra expenses. Closing costs can be as much as 4% of a home's value. Include legal fees, realtor commissions, appraisal fees and the property transfer tax. Don't forget about the cost of moving and doing a home inspection on your new place. You may also need to pay for renovations to help sell your old home or fix up your new one.
3. You can spend more on a new home than you think, now and in the future. The idea of trading an older, tired home for a modern condominium with granite kitchen countertops and high-end appliances can be enticing. But that new place can cost a lot more than you realize, seriously eating into profits from your sale. On top of what you'll pay for the property itself, there will be monthly maintenance fees, which are higher for complexes with amenities like pools and gyms. Also count on paying special levies from time to time to deal with major repairs.
Take the time to do a thorough investigation. You might conclude your move won't give you as much financial upside as you hoped.
Adding to your portfolio
Another important benefit of downsizing is that it will likely free up capital to help you better diversify your assets. Diverting net worth that has been tied up in your home to other investments like stocks and bonds, lowers your exposure to a pullback in real estate. At the same time, it opens up other growth and income opportunities. Be sure to consult with your advisor to review your investments, income sources, objectives and risk tolerance to ensure you invest your funds appropriately.
Even if you decide not to downsize, you can still take advantage of the home equity you've built up through what's known as "leverage" or borrowing to invest. When you're using borrowed money – typically through a home equity line of credit – you're putting more capital to work than you otherwise could, potentially lifting your overall investment returns.
A home equity line of credit, secured by your home's value, can give you access to lower borrowing rates and more flexibility than alternative home equity options like reverse mortgages.
When you borrow to invest, the interest charges you incur can be tax-deductible. And the higher your tax bracket, the greater your savings. Dollar for dollar, deducting interest expense through leverage can create the same tax savings as contributing to an RRSP, regardless of tax bracket. Investing the borrowed funds in tax-preferred options like dividend-producing investments can further enhance your returns.
But look before you leap. Leverage can ramp up your gains, but can also magnify your losses – so it's not necessarily right for everyone. Your BlueShore Financial financial advisor can provide advice on whether this strategy would be a good option for you.
Managing your mortgage
Downsizing while you're still making mortgage payments takes extra planning, especially if you want to use some of your new-found cash to pay out your mortgage early. The best situation is when you have an open mortgage where you can pay off the balance anytime without penalty.
Things get trickier when your mortgage is closed. Normally if you pay off your remaining balance before your mortgage term ends, you'll be subject to a prepayment penalty.
How much could you pay? That depends. You lender will consider a number of factors, among them the amount you owe, how long you have left on your mortgage term, whether you have a fixed or variable-rate mortgage, and the difference between your interest rate and current rates in the market.
If you're near the end of your term and have a small balance remaining, it might be worthwhile to pay a small penalty to get at your equity sooner and capture the benefits of downsizing your home. On the other hand, retiring a longer outstanding term and larger balance can be more costly.
If downsizing is in your plans, but down the road, look for ways to structure your borrowing to minimize future exit costs. Work to reduce your outstanding balance by taking advantage of prepayment privileges. Pay your mortgage bi-weekly instead of monthly. Consider a shorter mortgage term or weigh the potentially higher carrying costs of an open mortgage to enjoy more flexibility.
If you'll still have a mortgage after your move, determine if you have a portability feature that will let you transfer or "port" your mortgage to your new home. You'll avoid prepayment charges, keep your prevailing interest rate and retain the other features from your current mortgage. Restrictions and conditions can vary by institution so confirm how your mortgage works so you don't wind up saddled with unexpected costs.
A lifestyle choice.
Downsizing your home isn't always about money. Sometimes it's about lifestyle. Becoming an empty nester is a common reason to move. So are advancing age or health issues. Perhaps you're living alone and like the idea of moving into a retirement community to meet new friends or feel more secure. Or maybe you just want to escape the West Coast rain for good.
While the benefits of moving are often top-of-mind, the negatives sometimes aren't. Going from the big city to a small town, or from a large house to a condominium can be difficult to get used to.
Try before you buy.
Take the opportunity to "test drive" your plan to see if it's what you were expecting. Want to move to a small community? Try spending a few weeks there at different times of the year. You might discover the summers are nice, but the winters leave you with second thoughts. Is there too much peace and quiet? Do you have all the services you need, Do you have all the services you need, particularly those related to health care?
Considering a condominium or townhouse? Remember that you're also buying into the complex's strata rules. That means you can't paint the outside of your home the way you might like and you'll have to run renovations by the strata council first. If you're moving into a higher density location from a quiet single family neighbourhood, the noise and bustle may be more than you bargained for.
One way to lessen the risk of making the wrong decision is to rent for a while. By renting you'll find out if the convenience of a smaller home or central location is worth sharing walls with your neighbours.
The BC Seniors' Home Renovation Tax Credit
Thinking of installing a wheelchair ramp, hand rails or a walk-in bath to make staying in your home easier? The BC Seniors' Home Renovation Tax Credit, a $1,000 tax credit, is intended to help seniors 65 and older make permanent, structural improvements to their homes.
If you move to another province or leave Canada altogether you have more to think about than if you stick closer to home.
Consider taxes: income tax rates aren't the same across the country. Here in BC, the combined federal and provincial marginal tax rate on $70,000 of regular income is just under 30%. But move to Manitoba, for example, and that rate jumps to nearly 40%.
If you're leaving family behind it's likely that you'll be returning frequently to visit. Budget for travel medical insurance for when you leave your home province and count on extra travel expenses.
If you move abroad, add differences in culture, health care standards and property ownership rules to your evaluation list. Even your CPP and OAS payments could be affected. The federal government has produced a comprehensive guide, Retirement Abroad – Seeing the Sunsets which will help you understand the key issues to consider when leaving Canada permanently.
Alternatives to downsizing.
You've thought it through. You still need room for the grandkids, that extra-large dining room for entertaining and you would miss your neighbourhood too much. Maybe downsizing isn't for you after all. What are your options?
You can still tap into the value of your property without selling your house. A smart option is to establish a home equity line of credit. Because this loan is secured by your home, you're eligible for your financial institution's best rate. Payments can be as low as "interest-only". Plus you have the convenience of accessing funds only when you need them, without the need to reapply each time.
Accessing your home equity opens up possibilities. Instead of buying that new condominium, why not renovate your current home with modern features or to better suit your planned lifestyle? Or, invest those funds to create retirement income. You stay in your home while still getting the benefits important to you.
Is deciding to downsize your home a lifestyle or financial decision? In the end it's usually a little of both. Downsizing can be an effective way to unlock your home equity and enjoy the next stage of your life.
Do your homework. Take opportunities to explore your choices and understand the trade-offs. The best place to start? Contact your BlueShore Financial financial advisor. They'll help you make the most out of home, sweet home.