Should I Give Up a Low Interest Rate to Downsize?

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Downsizing is one of those ubiquitous practices that goes hand-in-hand with retirement, as if moving into your Golden Years is marked by a literal move into a new home. But if you’re still carrying a mortgage and intend to finance the purchase of your new smaller home, is it a good idea? Let’s take a closer look.

What’s the Rationale?

There’s a number of good reasons to downsize, including:

Trading in acreage or a multi-story property for a smaller, single-level set-up more conducive to aging-in-place; Moving into a home worth less than the one you own now so you can bank the profits to bolster your nest egg; and Relocating to an area that has a lower cost of living or is closer to loved ones who will care for you as you age.

However, even if the rationale is sound, sometimes the financial equation isn’t as straightforward. This is especially true when a downsize would entail losing a low interest rate on your existing mortgage. As of this writing, current mortgage rates for a 30-year fixed-rate mortgage are over 7%. Those who experienced the double digit rates of the late 1970s and early 1980s might argue that’s still a great deal; but let’s not forget: rates haven’t been this high in over two decades.

That’s why it’s time to check the math.

Does Downsizing Make A Lot of Cents?

For argument’s sake, let’s say you borrowed $300,000 in a 30-yr fixed rate mortgage when rates were 4.25%. Your monthly payment is $1,476. How would your current payment compare if you:

Buy A House of Similar Value…

With a 30-year fixed rate mortgage at today’s rate of 7.396%, your monthly payment would be $2,076.

VERDICT: $600 more per month

Buy A Less Expensive Home with a 15-Year Fixed…

But we’re talking about downsizing, so let’s say your new mortgage is $200,000. You choose a 15-year fixed rate mortgage at 6.27%. Your monthly payment is $1,717.

VERDICT: $241 more expensive per month

Buy A Less Expensive Home with a 30-Year Fixed …Suddenly the 30-year fixed at 7.396% looks more attractive. Certainly, the monthly payment could offer some significant savings, right?

VERDICT: $92 per month saved

Now that we found some savings– albeit a small one– it’s time to break the bad news. These numbers don’t take into account the other costs associated with buying and selling a home, like closing costs, movers and realtor fees, which essentially eats up your $92 per month windfall for years to come.

To be fair, you’d still realize some savings in your property taxes from downsizing, assuming you remained in the same county or moved to one with a lower rate. Plus, assuming you have equity in your old home, any money you earn from the sale could provide a nice cushion to your retirement fund. But unless you’re buying your new home in cash, that 7% rate on your new mortgage would be eroding your profit over time.

So, is downsizing a good idea if it means trading in one mortgage for another with a higher rate? Probably not. But to be sure, run the numbers and talk through all of the influencing factors with your retirement planner.

Are you asking your financial planner the right questions?

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