Retirees: Consider Downsizing to a Rental

NEW YORK (MainStreet) — Older homeowners are often urged to consider "downsizing" — selling the big family home and using the proceeds to buy a cheaper one and put some cash aside. But there's another downsize option that's rarely discussed: selling the old home and becoming a renter.

Clearly, this goes against the grain, as most people prefer owning to renting. But would the own-to-rent downsize ever make sense? It's worth some thought.

In a standard downsize, the long-term homeowner, typically someone in or near retirement, sells the big home in which the children were raised, then buys something that is cheaper, has lower taxes and utility costs and is easier to maintain. Ideally, the equity on the old home is more than enough for the homeowner to pay cash for the new one, and the difference goes into a rainy-day fund or investment.

But there are several circumstances that might make it pay to rent the new home rather than buy.

The rental, for example, requires less cash upfront than a cash purchase. Imagine you sold a $400,000 home owned free and clear and had a choice between buying a $200,000 condo or renting a comparable apartment for, say, $2,000 a month. You might get into the rental for advance rent and security deposit of $6,000. You'd keep $394,000 from the home sale (not including selling costs such as Realtor's commission), compared with $200,000 if you bought the condo.

This could be appealing if you had a special need for that extra cash, or if you saw a juicy investment opportunity. If you were willing to risk the stock market, the extra $200,000 might grow enough to offset some of what you'd pay in rent. Of course, that investment gain should be compared to any appreciation you might get on the condo if you bought it.

Another reason to rent: You might not be sure you would stay put long enough to justify buying the condo. Perhaps you're not sure condo life is for you, or that you'll like the new community well enough or be able to handle future increases in condo fees. Or maybe you worry that deteriorating health will force you or a spouse to an assisted-living community.

In that case, renting might give you more flexibility to move on in the next few years. As a rule of thumb, it doesn't pay to buy unless you expect to stay put at least four or five years. That should provide time for gains in your home's value to offset the expenses incurred in buying and selling, such as transfer taxes and Realtor's commission.

After all, if you rent, you can easily change your mind, get out when the lease expires and rent or buy another place.

The downside, of course, is that when you rent you do not have equity, and you can expect rents to rise with inflation. Recently, rents have been going up so fast that many renters are finding it cheaper to buy. Of course, the costs of owning a home go up too — things such as property taxes, insurance, maintenance and any association fees.

It's a tough call, but probably boils down to this: If there's a better-than-even chance you won't stay in the new place longer than five years, renting may be the best option. If the odds favor staying longer than 10 years, buying will probably pay unless you have good reason to expect a big investment return on the cash saved by renting.

Between five and 10 years it's a tougher call and will hinge on a detailed look at the numbers: rent and likely rent increases, purchase prices and likely increases in ownership costs, potential investment returns on cash that is not used for a purchase. Use the Rent vs. Buy Calculator to check the numbers.

One thing you can be sure of: Renting will be a loser if you squander the extra cash from your home sale. The equity freed up in a downsizing should be put to work, so it will grow — not frittered away on fancy dinners, cars or other expenditures that have no long-term payoff.

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