Downsizing Your Home: Using Home Equity to Buy a Smaller Home

What is downsizing?

Downsizing your home is a big step, and moving from a larger home to a smaller one requires a great deal of preparation.

Most people find it delivers real financial advantages and can leave them with more money to spare every month. But there’s a lot to think through, like how do you cram the contents of a large home into a smaller one?

Then there are other considerations, such as how best to finance your next home. And all of these things will depend on the stage of life that you’re at.

In this article (Skip to…)

• Pros and cons of downsizing
• Factors to consider
• Using your home equity
• Alternative ways to finance your downsize
• Take your time when downsizing
• Is downsizing right for you?
• FAQ

Who typically downsizes?

We tend to think of downsizers as older folk: empty-nesters, those approaching retirement or the recently bereaved. But plenty of others take the step, and divorce, the back-to-the-office movement, tiring of the maintenance burden of a big home, and financial issues are all common triggers.

Each of those groups — and the individuals who make them up — can have very different answers to the question of how to downsize your home. So, let’s explore what might be important to each group.

The pros and cons of downsizing your home

Pros of downsizing

Whatever your motivation for downsizing, saving money is likely to be an important consideration.

Homes.com and Gransnet each conducted surveys of borrowers who downsized. Many respondents cited saving money as their main reason.

While you’ll likely save on your monthly mortgage payment, smaller homes tend to come with smaller bills for property taxes, utilities, homeowners insurance, homeowners association fees (where applicable) and maintenance.

Of course, saving money isn’t the only advantage of downsizing. The Homes.com survey found plenty of respondents mentioning other benefits, including:

1. The previous space was too big
2. The previous space was too difficult to clean and maintain
3. A smaller home would be less stressful
4. Downsizing your home is an opportunity to declutter

The popularity of those reasons varied between generations. On average, baby boomers (born from 1946-1964) were less interested in saving money than Generation X (1965-1980) and millennials (1981-1996). The younger borrowers were also less likely to complain that their previous place was too big.

Baby boomers are less likely than younger homeowners to be under financial pressure to move. That makes sense since the early years of homeownership are typically more financially challenging than later ones. Additionally, divorce is more prevalent for younger couples than spouses in their 60s or 70s.

Cons of downsizing

Strangely, neither the Homes.com nor Gransnet surveys mentioned the costs of downsizing your home. But buying, selling and moving aren’t cheap endevours.

The most cited downsides in the Homes.com survey were:

1. Having to get rid of possessions
2. Becoming more distant from family and friends
3. Feeling more lonely than in the previous place

The same survey asked about the most challenging adjustments required after downsizing. And the three biggest responses were:

1. Having less space
2. Having less privacy
3. Being farther away from family and friends

It’s also worth noting the logistical issues that come with downsizing your home. You’ll need to get rid of a lot of stuff, and that involves sorting items into keep, give away, sell, donate to charity, and discard.

A popular suggestion for this process involves making a full spreadsheet inventory of all your possessions, including the dimensions of larger objects, to help organize and lay them out in your new place.

Factors to consider before downsizing your home

Financial goals and impact

If you need to downsize for financial reasons, it’s a good idea to start by looking at your household budget. Ask yourself some questions:

1. How much do I need to get out of financial trouble?
2. How much do I need to save each month to stop myself getting back in trouble?
3. Will I need to use some of the proceeds of the home sale to pay down debt or meet other obligations?
4. If so, will I have enough left for a 20% down payment on the smaller home? (If not, build mortgage insurance premiums into your future mortgage payments)
5. Should I consider keeping my existing home as a rental investment and buy the smaller property using my home equity? (Only an option if you have plenty of equity. Read on for more on this)

There may be opportunities to make some smart choices at this point. So consider running your ideas past a financial adviser or accountant. They might come up with some clever ideas for maximizing the benefits you realize.

Get the financial side straight in your head before looking at prospective homes. It’s much better to know your purchase budget before you fall in love with a property. Mortgage calculators can help you set your purchasing budget.

Long-term plans

Think ahead. We’ve already established that home selling, buying and moving is a costly business. So, you don’t want to find yourself moving again too soon.

For example, many older people move to be closer to their children and grandchildren. If that applies to you, it would make sense to first be sure that they won’t be moving on to a new location in the near future. Younger adults tend to relocate for work more often than older employees.

Similarly, if you have a health condition, you might want to be close to a hospital that has the resources needed to treat you. Don’t find yourself driving hundreds of miles for every consultation.

Younger people will likely wish to be close to their workplaces. That’s great if your job’s secure. But what if a recession comes and you’re made redundant? Might it be better to have a slightly longer commute now if that means a shorter one when you change employers?

Current real estate market and whether you plan to sell before you buy

Will you sell your existing home before you buy the one to which you’re downsizing? Or will you purchase the next one before listing the current one?

For many, the answer is inevitably the first. But those with lots of equity have a choice. We’ll define home equity and explain how this works a little later in this article.

The dynamics of the housing markets where you’ll be selling and buying are crucial to your decision. Will you find it easy to sell? Or will finding and buying a place be more difficult?

If you’re in an extreme seller’s market, being a cash buyer can make all the difference between your offer being ignored or considered. Read on for how you might be able to become a cash buyer by getting a home equity loan upfront.

Amenities, neighbors and community

This section doesn’t apply just to downsizing, it’s standard advice for all home buying.

You need to deeply research the neighborhood where you’ll be buying, including several visits at different times of the day. That way, you’ll have a better idea if it’s somewhere you’ll be happy for many years to come.

We already mentioned how people with medical conditions might want to be close to appropriate care. But there are countless other considerations that you need to think about.

For example, if you love walking or cycling, you may want somewhere close to stores and trails. If you’re sensitive to noise, make sure there’s no rail track or airport nearby, and that you’re not neighbors with a fire department.

Perhaps you want a particular type of church nearby. Or to be sure that a club of which you’re a member (Rotary, Inner Wheel, Round Table, Lions club, Buffalo club …) has a local presence. Or you may have an interest in a particular sport so you find a place with nearby courts or fields.

Handling possessions and storage needs

We covered the logistical challenges of ridding yourself of the possessions that won’t fit in your smaller home. That means you may want to put some of them in storage.

But don’t think of that as a long-term solution except for items of sentimental or occasional practical value. Many end up barely visiting their storage units while paying fees as their once-prized furniture and belongings slowly deteriorate. Unlucky ones see their stuff years later on Storage Wars.

Using your home equity for downsizing

What is home equity?

Home equity is the current market value of your home, minus the balance on your existing mortgage(s). In other words, it’s the proportion of your home’s value that you own outright.

Home equity loans and home equity lines of credit (HELOCs) are second mortgages. So, you have to deduct the balances on those as well as your first (main) mortgage when calculating your own home equity.

Can you use home equity for a down payment on a second home?

If you have lots of equity, you could get a home equity loan for your next down payment. You can then buy the downsizing home with a mortgage before you sell your existing one. Once your current place sells, you can pay down the home equity loan. Just make sure yours doesn’t have prepayment penalties.

Indeed, if you have loads of equity you might be able to buy your entire next home with a home equity loan that you later pay down with the proceeds of your eventual sale. Or perhaps you’d prefer to keep your larger place as a rental investment.

Can you sell a home after taking out a home equity loan?

Yes. But you must redeem (pay off) the home equity loan when you close your sale.

Of course, if you have enough equity in the home you’re buying, you can get a new home equity loan using that as collateral.

Alternative ways to finance downsizing your home

Many downsizers don’t need mortgages. They’ve reached the point in life where they’ve paid down or nearly paid down their mortgage and crave a simpler way of life. Maybe they’re about to retire or are empty nesters.

Downsizing promises them a better way of life with no mortgage or rent, lower homeownership outgoings, and usually a gap between the sale and purchase prices that provides a handy lump sum.

However, many other downsizers do need mortgages. And they can choose from the same selection as other home buyers.

Types of mortgages when downsizing your home

If possible, they’ll likely choose a conventional mortgage (any not backed by the government). If their down payment is less than 20% of the purchase price, they’ll probably have to opt for one that conforms to Fannie Mae or Freddie Mac’s rules (“conforming loans”). Those can have down payments as low as 3%.

However, you need a credit score of 620 or higher to qualify for any conventional loan. So, if yours is in the 580-620 range, you’ll likely need an FHA loan. You’ll need a down payment of 3.5%. If you have a 20% down payment, you may be able to get an FHA loan with a credit score as low as 500.

And if you need to raise your FICO score fast, here’s a list of tips to follow.

If you’re eligible for a VA loan (a military veteran, service member or in a closely related group) or a USDA loan (have a modest income and are buying in a rural area), you won’t need a down payment. But you might need a higher credit score than the FHA allows.

It’s good to know a modest income doesn’t necessarily bar you from a new mortgage. Many seniors who rely wholly on Social Security can get approved.

Take your time downsizing your home

If you have a choice, take your time when you plan and execute downsizing your home. Doing so can provide real benefits.

If you’re very lucky, you may be able to time your move during a period when home prices are strong where you’re selling and weak where you’re buying. Or you could choose to take advantage of seasonal changes in those prices and moving costs. It’s cheaper to move at a time of year when few others are.

More often, you can just think through the consequences and plan to maximize the upsides and minimize the drawbacks. Consult family, friends and professionals for ways to do that.

Pay attention to how you finance your move. Do you need a mortgage or a home equity loan? If so, which type of mortgage suits you best?

Devote several hours to tracking down the best possible deal on your financing. Lenders’ offers vary widely and you could save a lot by comparison shopping.

Also, carefully consider the logistics. Which of your possessions will fit into your smaller home? And which must you dispose of? The longer you spend on this, the happier you’ll likely be with your choices.

Importantly, don’t become overwhelmed by these challenges. Plenty of people successfully downsize all the time. There’s no reason you shouldn’t join them soon.

The bottom line: Is downsizing right for you?

Many who are downsizing have no choice in the matter. They might be recently divorced or bereaved. Or they could find themselves facing otherwise-insurmountable financial challenges.

For many others, however, downsizing is a choice. They may be empty nesters or struggling to maintain a large house and yard. Or they might just crave a simpler lifestyle.

If you fall under any of these categories, reach out to a local mortgage professional and start your downsizing journey today.

FAQ

How do I start downsizing my home?

If financial reasons are a big part of your downsizing plans, start there. Work out how much you want or need to save so you can identify your maximum purchase price. Use mortgage calculators to see what you can afford.

Then address the logistical issues of finding, financing, buying and moving to a smaller home.

When is the right time to downsize your home?

Many who are downsizing do so under financial pressure and have little choice over when they act. But those who aren’t can try to time their sale, purchase and move to maximize the benefits they enjoy. They also have more time to plan their downsizing.

Is downsizing your home a good idea?

Downsizing your home may be the only idea open to you. Otherwise, only you can decide whether it’s a good idea. We laid out the pros and cons, above. Read them again and see how they apply to you.

How can I buy a second home without selling the first?

Home equity can be your friend here. If you have a valuable home and a low mortgage balance, you can leverage most of the difference as security on a home equity loan. Depending on how much of this equity you have, you might be able to finance your down payment or even buy outright the whole, smaller home.