If Downsizing, Consider How You'll Finance a New Home
Should you pay cash for your new house? Your money may earn more in other investments.
The kids are safely out on their own and retirement is at hand. If you're planning to sell your now oversized home for something smaller and easier to maintain, the first issue you'll need to tackle is how you'll finance the new house.
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Most downsizers no longer need to worry about taxes. For couples filing jointly who have lived in their home for at least two of the five years leading up to the sale, $500,000 in profit is tax-free. Many downsizers who are flush with cash from the sale of their old home, choose to buy their new home outright, freeing themselves from monthly mortgage payments. Although this might sound attractive, it may not be your best option, especially if you consider the tax benefits.
Crunching the Numbers
Let's compare the Smiths and the Joneses. Both couples, comfortably in the 25% tax bracket, collected a cool $80,000 on the sale of their old homes and have their eyes on a tony little lake community with houses in the $200,000 range.
Both couples took 15-year fixed-rate mortgages at 5% interest. (You may be able to get a 15-year mortgage for as little as 3%.)
The Smiths decided to put the full $80,000 down on the house, believing that they'd save more by having a lower monthly payment ($949 for principal, interest).
The Jones opted to put only 20% (or $40,000) down to avoid paying private mortgage insurance. They invested the other $40,000 in a balanced portfolio of stocks and bonds earning an average 6% annually. Their monthly payment is higher -- $1,265 for principal, interest -- but by the end of the loan term they actually have about $2,000 more than the Smiths because of higher tax deductions and earnings from their investments.
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If your investment returns are higher or the mortgage rate lower, the returns would be even greater. And that's not even counting the home's appreciation and the power of leverage (using borrowed money to generate a return).
In addition to a bigger bottom line, mortgagers like the Jones enjoy increased liquidity by not tying up cash in real estate, which could be hard to sell in an emergency.
Keep in mind, though, that qualifying for a mortgage as a retiree can be more difficult than qualifying during your working days. And your estate-planning goals may also influence how you decide to pay for your new home.
Before you make a commitment to pay cash or borrow, run your proposal by an estate lawyer to make sure it complements your overall plan and doesn't create problems for your heirs.