- Housing is primarily a lifestyle choice, not an investment. But unlocking equity and lowering the ongoing costs of ownership can improve finances.
- To overcome high transaction costs, aim to downsize by 25% or more if you are moving to improve your finances.
- Consider downsizing early in your retirement to maximize the benefit of cost savings.
When you buy a place to live, people often remind you it could be the biggest investment you will ever make. But a home is a lot more than just an investment. A home is shelter, to start with, but also an important part of your lifestyle, memories, and more. The many roles of a home make converting the value of your property into income a lot more complex than selling a stock and tallying up any profits.
Still, for many Americans, their home is their most valuable asset and a large portion of their total wealth (see chart). It’s also a big part of spending—accounting for almost a third of all money spent. That makes it worth considering the financial side of homeownership, along with the other facets of your home, as you build your retirement plan. For many people looking to decrease the risk of running out of money in retirement, deciding to work longer and choosing a home are the decisions with the greatest potential impacts.
If you want to consider using home equity, your options include a reverse mortgage and a home equity line of credit. But perhaps the most common approaches to reducing your housing expenses are downsizing to a smaller home in the same area, or relocating to a less expensive area, or combining elements of both—relocating to a smaller home in a less expensive area.
To really understand the financial impact a move might have, you have to consider more than just the potential sale price or equity in your home. The price of a new home, the taxes and costs connected with the transaction, changes in the cost of ownership, the cost of living (COL) in the new area, and other factors will all help determine just how much of a difference a move could make for your retirement income.
"Housing plays a huge role in personal finances and wealth," says Andrey Lyalko, vice president at Fidelity. "The impact of reduced costs on retirement planning, and the potential to walk away with some cash from the sale of a home, make housing a key part of a retirement income strategy."
The overlooked impact of costs
If you have owned a home for a long time, you may have seen the value of your home rise significantly. What’s more, you might have built up equity as you paid off a lot of your mortgage. If you sell and walk away with some cash, you can convert that into a stream of income. But it is easy to overlook the common costs of a real estate transaction. Along with the price of a new home, realtor fees, closing costs, moving fees, and the money that goes into redecorating all take bites out of your sale price. Estimates suggest these costs could average as much as 13% of the sale price of a home.
The impact of transaction and moving costs on profits will be even greater. Consider the sale of a home worth $500,000 and then a purchase of another home for $400,000. If costs add up to 13% of your sale price of $500,000, you have spent $65,000 by the time you are moved into your new home. That’s 65% of the profit you were going to use for retirement.
To overcome the high costs of moving, we suggest looking for a house that costs at least 25% less than your current home. This big reduction in price should mean that the savings from the move can ultimately be worth more than the added expenses. A 25% reduction may still not leave you with a huge cash inflow, but it is not the only benefit to downsizing.
Some major expenses drop when you move to a less expensive residence. Taxes, insurance, utilities, and maintenance costs all tend to scale with the price of a home, as they may average more than 4% of the sale price of a home each year. Reducing those ongoing costs could go a long way toward improving your retirement picture. If you relocate, the potential cost-of-living changes can make a big difference too.
"People tend to focus on differences in the prices of homes, while transaction costs and ongoing expenses tend to be overlooked," says Lyalko. "But for a retirement plan, those lower costs can make a big difference, sometimes far more than the lump sum realized by selling."
A case study: A move to save
To see just how much of an impact a move might have, let’s look at a hypothetical example. A couple is able to generate approximately $5,000 per month in retirement income and they are finding it is not providing the lifestyle they want. However, they own a home worth $750,000 with no mortgage. Let’s suppose they sell the house, and buy a smaller home for $500,000, again without a mortgage. The deal would produce a $250,000 gross profit, but they need to make changes to the new house, buy furniture, pay the realtor, the taxes, the movers, etc. We estimate that this would end up costing about $87,500, or roughly a third of the profit, leaving them with a $162,500 lump sum.
What does that mean for their retirement income? Assume that their taxes and cost of living stay the same. Also assume that they want to make their savings last, so they decide to spend about 4% of their savings each year. In this case, the lump sum could mean an extra $500 a month for the rest of their lives. So they decide to spend about 4% of their savings each year, that lump sum could mean an extra $500 a month for the rest of their lives. But, the move will also result in lower ongoing expenses. Repairs, insurance, heating, cooling, taxes … all of those costs should drop as well. In fact, we estimate that these cost savings could total about $700 per month. That means the couple’s retirement cash flow could improve by an estimated total of $1,200 a month.
Taking it one step further, what if they bought a $500,000 home in a part of the country with a lower cost of living? Let’s suppose they relocated to another state with a 11% lower cost of living. The decreased costs in the new location could allow them to improve their standard of living by the equivalent of $2,200 a month. These additional monthly savings could mean even more in a place that costs less, and so could their existing retirement income. In total, the increased retirement income from the sale of the home, combined with the lower cost of living, could feel like a $7,200-a-month lifestyle. Put another way, this couple could increase the purchasing power of their retirement income by almost 50%, by downsizing and relocating.
Where to live is more than a financial decision. Leaving your memories may be difficult. Family and friends will likely also influence where you relocate in retirement. However, because housing is such a large part of our expenses and such a large store of wealth for so many people, it can be a powerful lever when it comes to the financial side of retirement. That’s why it’s critical to consider carefully where you will live as you map out your retirement income plan.
Next steps to consider
Review your retirement strategy.
Try the Planning & Guidance Center.
See the pros and cons of paying off your house early.