In this episode of Next Act Ninjas, Rachael Van Pelt empowers you with a game-changing strategy for accelerating your financial independence through downsizing. In previous episodes, we've separately explored how downsizing can reduce living expenses and the steps to achieving your financial independence (FI) number. But today, we're creatively merging these concepts to maximize your wealthspan. Imagine adding a quarter of a million dollars to your nest egg simply by buying your downsized property now rather than later. Intrigued? You should be! We'll delve into the numbers, comparing the benefits of buying a downsized property now versus later, using a real-world example of a couple navigating this decision. We'll break down the potential rental income, tax benefits, and property appreciation to reveal how making a proactive move can significantly boost your retirement savings. Join us as we crunch the numbers and discuss the pros and cons of each approach, providing you with actionable insights to make informed decisions. Whether you're looking to lock in lower property prices, generate rental income, or reap tax benefits, this episode will equip you with the knowledge to leverage real estate for accelerated financial independence. Tune in and discover how to turn downsizing into a powerful tool for wealth building. Subscribe now for more empowering insights and strategies to master your lifestyle longevity. Live well, love more, age less, Ninjas!
Chapters
00:00 Introduction: Downsizing to Accelerate Financial Independence
02:27 Analyzing the Numbers: Buying Now vs Buying Later
09:57 Pros and Cons of Buying Now vs Buying Later
11:49 The Bottom Line: Potential Returns on Investment
14:55 Taking Action: Exploring Downsizing Options
Welcome back to Next Act Ninjas, the number one podcast for becoming a master of your lifestyle longevity. I'm your host, Rachael Van Pelt, and I am so excited for today's topic. We're going to talk about downsizing to accelerate your financial independence. In previous episodes, we've talked about downsizing to reduce your living expenses. And we've talked about steps to achieving your financial independence or FI number. But today, I want to talk about creatively marrying these two concepts to maximize your wealthspan.
What do I mean by that? I mean, if you think that you will downsize within the next 5-10 years, why not leverage that knowledge to accelerate your retirement savings? What if I told you that you might be able to add a quarter of a million dollars to your nest egg simply by buying your downsized property now rather than later? Would that pique your interest? It certainly piqued mine when I ran the numbers.
Many of us, we find ourselves in a bigger home than we need as the kids start growing up, don't we? They're growing up, they're moving out. We no longer need the large four or five bedroom home in our preferred school district. So we start thinking about next steps, which is totally natural, right? But maybe we aren't quite ready to say goodbye to the old neighborhood, or we still have a few years before our youngest flies the coop, or maybe we just feel like that 3% mortgage interest rate is too good to part with. There are many reasons that we may not be ready to downsize just yet, but we plan to do it sometime in the near future.
So I want to talk about how we might use that knowledge to our advantage. Let's do a deep dive on the numbers for buying now versus buying later. And bear with me, I know not everyone appreciates number crunching, but you will appreciate the bottom line.
We're going to start with, Mark and Kenzie, a couple who currently live in a beautiful $850,000 home. They have about $350,000 left on their mortgage, and the mortgage is a 3.1 % interest rate. It's hard to part with, isn't it? Homes in their neighborhood, they are appreciating at a solid 6% per year on average. They plan to downsize in six years to an area where townhouses are currently valued around $490,000.
Now the question that they are contemplating is, should they buy that townhouse now or should they wait until later? If they buy the townhouse now, they will pay less money than if they wait six years, won't they? And if they rent it out in the meantime, they might be able to grow their nest egg. But they know interest rates on a second home are 7%. They don't have much cash for a down payment. And many people have told them just put the money they would invest into that rental or that townhouse into paying off their existing mortgage so that they have more equity in the home when they sell and they can simply buy their downsize later with cash.
But, I want to break down the numbers and see if that's really the best option. Let's break down the numbers for buying that townhouse now. If they decide to buy now, they're going to be able to rent that townhouse out for at least $2,200 per month based on going rates. Homes in the townhouse's market, they're approaching at about 4% per year appreciation. They don't have a lot of cash, so they're going to need to use their home equity line of credit (HELOC). They have a $100,000 HELOC that they could use for their down payment, but it is a 9% interest rate. But they can finance the remaining $390,000 with a 30-year-fixed mortgage at about a 7.2% interest rate.
Of course, if they use a HELOC for their down payment on the townhouse, it is going to cost them around $54,000 in interest payments over the six year period. But fortunately, those interest payments are tax deductible. They're going to get back about $19,000 in tax breaks when all is said and done. And by renting out that townhouse for $2,200 per month, they're going to bring in about $140,000 over that six year period after accounting for some expenses. That nearly covers the mortgage, but not quite. They are going to need to cover a gap, a gap between the rent and their mortgage payment, and they're going to have to pay off some HELOC interest. And that's going to amount to about an extra $1,200 per month that they're going to have to make up.
That's going to mean they're going to have to tighten their expenses. But by the end of six years, their current home value is going to grow to about $1.2 million. And the townhouse value is going to grow to about $620,000. So when they sell their primary residence in six years for $1.2 million and they pay off the remaining mortgages on those two properties, and they pay off that $100,000 HELOC,they're going to be left with about $500,000 in cash to put towards their retirement. And they're going to have a fully paid off $620K townhouse to live in mortgage free.
But let's look at the numbers for buying later. What if they wait? If they wait to buy that townhouse in six years, if they're going to be tightening expenses anyway, why not instead put that same $1,200 per month towards their current mortgage, as people have suggested they might do? This will accelerate their payoff. That'll bring their mortgage balance down to about $205,000 in six years.
Their home will still appreciate to $1.2 million and they'll have more equity in it, but they will now have to buy the townhouse at its appreciated value of $620,000. They also won't have had any tax savings along the way. So at the end of the day, after selling their primary residence and using the proceeds to buy the townhouse, they're going to only be left with about $375,000 in cash rather than the $500,000 in the prior scenario. They're still going to have a fully paid off townhome, so that's great. They're still going to be able to live mortgage free.
But the bottom line is buying the townhouse now and renting it out will give them approximately $125,000 more for their retirement in just six short years. And if they're savvy about reinvesting the money they saved on taxes in the first scenario, they may accrue even more. Any tax refunds they get can go into their catch-up payments on their 401k or their IRA.
And one thing I want to point out is in both of these scenarios, our couple is planning to tighten their expenses over the six-year period to reach their goal. That allows for an apples-to-apples comparison. However, in the buy later scenario, they do have the option to not aggressively pay down their existing mortgage. That flexibility is one of the benefits of waiting to buy later.
But if they don't put that extra $1,200 every month towards their mortgage, then they will have even less money left over in the buy later scenario. If they do not put in any extra effort to tighten their budget over the next six years, they're going to be be going to left with only $275,000 when all is said and done. That's $225 ,000 less than the first scenario, the buy now scenario.
I don't know about you, but I think that's a great return on investment in the short term simply by tightening up a little bit. Now it's important to note that this is a simplified example. Your individual results are going to vary, of course, based on your specific circumstances, your interest rates, property values, local rental markets... All of that could be very different. So you're going to want to consult with an expert mortgage lender and a Realtor that specialize in working with investors in the market you're dealing with.
But this is an investment we're talking about. It's not simply a move to a smaller home. That's why buying now versus later works in your favor. You are leveraging real estate to grow your nest egg between now and when you're ready to make the move.
Okay, but I realize that's a lot of number crunching to throw at you, so I want to quickly summarize the pros and cons of each of these scenarios without the numbers. Again, buying the townhouse now scenario, the pros are you get to lock in a lower price on the downsized property before it appreciates. You get to generate rental income to offset those mortgage payments and potentially profit. In some situations, you can fully cover the mortgage. You're also going to benefit from tax deductions on your mortgage interest and property expenses.
The cons of buying now are you're going to need to finance a down payment. If you have cash, that's great. If not, a HELOC can work. You just have to keep in mind that you're going to be paying a higher interest rate on that HELOC, and that's going to cut a little bit into your profits.Another con is it does require financial discipline to manage two properties and cover those rental gaps.
Now if you buy later, the pros are you're going to have more flexibility with your finances in the short term. You can simply choose to do nothing. You can also potentially increase equity in your current home if you aggressively pay down the mortgage. Perhaps you even decide not to downsize in six years because your mortgage is fully paid off. I don't know, maybe you decide you'll stay in that bigger property. That's fine too.
The con of buying later is you're going to miss out on potential rental income, tax benefits, all of which contribute to your bottom line. And you're going to pay more for that downsize property in six years than you would today due to the appreciation.
The bottom line is the numbers don't lie. By buying the townhouse now rather than later, Mark and Kenzie could potentially net an extra $125,000 to $225,000 for their retirement in just six years. That's a massive return on investment. That's because they're going to have a combination of rental income, tax savings, and property appreciation on two properties.
Now if they stay in their current home and aggressively pay down the mortgage, that's still better than nothing. That's going to earn them nearly $14,000 back on that investment compared to simply doing nothing. But if they're going to be disciplined with their budget for the next six years anyway, why not get the most bang for their buck and invest in the property now?
Keep in mind if their timeline is shorter, say just two years or longer, closer to 10 years, the numbers are going to look very different, aren't they? A 10-year investment will yield a much greater return. A 2-year time period, not so much. But that's the same with any investment, isn't it?
Regardless, I want you to come away with four key takeaways from today. Number one, proactively plan. If you're going to downsize within the next 10 years, don't wait, start now. Number two, leverage real estate. Buying property is a powerful tool for wealth building, even if you only hold it for five years. Three, consider the tax benefits. Don't overlook the tax savings you're going to get from deductions on mortgage interest, property expenses, depreciation. You can save even more on taxes if you do a cost segregation analysis, but that's a topic for another day. And four, consult with experts. Make sure you get personalized advice to make the best decisions for your specific situation, your specific market.
And seriously, have fun with this. Explore your options. Just knowing what the numbers will look like for you can be incredibly empowering. I know my husband and I, when we crunched the numbers for ourselves, we were just so excited. It was a complete no-brainer for us. We already own properties, so we know the work involved up front, and we understand the returns that we can expect. Moreover, if we buy in a place that allows short-term rentals, we could potentially earn even more over a 5-year timeframe.
Is buying a downsize 5-10 years early for everyone? Of course not. But for those of you who can make it work, I think it's a great way to accelerate your savings and reach your financial independence sooner than later. Catch up to FI, as they say.
Now, if you're intrigued by the idea of downsizing to accelerate your financial independence, start exploring options today. You can always hop on my calendar. You'll find the link in the show notes. And I can help you create a plan that's going to be aligned with your specific goals. And I can connect you with a numbers guy that can run the calcs with you if you need that. Remember, taking action now could be the key to unlocking your financial independence sooner than later. Once you know whether the numbers will work for your specific situation, then comes the fun part of finding that forever home to downsize to.
That's all I have for today. I'm Rachael Van Pelt. Thank you for joining me for another episode of Next Act Ninjas. Don't forget to subscribe for more empowering insights and strategies to master your lifestyle longevity. Until next time, live well, love more, age less, my friends.