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08/28/2015 07:09 am ET Updated Aug 28, 2015

Why Downsizing In Retirement Might Be A Terrible Idea

Prevailing wisdom may be changing on what was once assumed to be the right course.

The prevailing advice for retirees and their first cousins -- pre-retirees -- is to downsize their homes. The logic goes like this: With your kids launched, you no longer need so much space. Plus living in a smaller home will reduce your utility and maintenance bills as well as your taxes. Less expense and less time cutting the grass or fixing things equals more time and pocket change left to enjoy your retirement, or so the conventional wisdom goes.

That same prevailing logic also says that for many Americans, most of our retirement money is in our homes -- and that's a bad thing. We have accrued substantial equity because prices rose substantially since we bought our houses many years ago. The problem is that the equity in our homes isn't liquid -- meaning you can't draw from it to buy your weekly groceries or pay your bills. It's just there, not doing you a whit of good until you sell your house and can take it out.

And there is a third prong in the argument that favors downsizing. Most financial advisors recommend a balanced retirement portfolio. If half of your wealth is tied up in your house and you can't touch it, you are limiting the income you will need to live in retirement. 

So to recap: You are paying for space you no longer need and what you really do need is a larger monthly cash flow. The problem is your money in your house isn't accessible to you when you need it.

So it makes sense that we should all just rush out and downsize, right? Actually, maybe not.

Downsizing to a smaller and less expensive house isn't the right course for many people, some experts are now saying. For one thing, your new home may not be sufficiently less expensive. Smart About Money, a program of the nonprofit National Endowment for Financial Education, says if downsizing doesn't reduce your home expenses by at least 25 percent, it isn't worth the bother. When you are calculating expected savings, consider taxes, utilities and maintenance too. But also consider things like a higher utility bill for air conditioning/heating if you are moving to a harsher climate; whether car insurance is higher in your new location; whether seeing your grandbabies and long-time friends will now require a plane fare.

There's another thing to consider as well: The costs involved with downsizing. There are substantial expenses involved in selling your house and buying a new one; paying a real estate agent a 6 percent commission is a big chunk of change. Moving companies are expensive. Utilities sometimes charge you for opening or closing an account. If you are going to pay thousands in real estate and closing costs plus more thousands to a moving company to lug your belongings somewhere new, how long will it take you to recoup those expenses if you are only saving $350 off your monthly housing note?

Another hit-the-pause-button moment comes if you are already living mortgage-free. This would mean your monthly housing costs are low already and it's just a matter of needing more income. Are there less traumatic options to selling and moving? Can you rent a room out, make the garage an income-producing studio rental? 

It may be a tendency of human nature, but one thing that often happens when people move to a downsized home is that instead of reinvesting the money in an active income-producing vessel, people immediately rush out to remodel their new home or buy a fancier car. They enjoy fixing up their new home and wind up spending too much on a remodel. If you feel hooked on real estate, maybe use some of the liquidated equity to buy rental-income property. While your tenants' rent will likely increase every year, your mortgage payments on your rental property will not.

Bottom line: If your downsizing savings don't amount to very much, it doesn't make much sense to leave a home you love for a new one. Other ways to get cash out of your house might be to rent out a room to someone or to list all or part of it on a peer-to-peer vacation rental service.

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