Should you downsize your home if you're in debt?

If you're wading in debt and housing costs and your five-bedroom house is feeling more like a ball and chain than a restful home, downsizing to a smaller, less expensive home may seem like the solution.

"It's not uncommon for people to buy too much house," says Jason Heath, a certified financial planner and managing director of Objective Financial Partners Inc. "Now more than ever, with real estate prices where they are in most Canadian cities, we have more people finding themselves in house-rich, cash-poor territory."

However, it isn't a cookie-cutter answer for all. The expenses involved in downsizing your living quarters might stretch your budget, or your housing costs may simply not be the problem. Here's how to determine if a smaller home is right for you.


Consider all of the expenses involved in downsizing
"One of the challenges with downsizing is all the transaction costs involved," Heath says. "A lot of your savings are eaten up in these costs and if you're going to do a downsize, it has to be fairly significant to even net some savings."

Downsizing means selling your current home and moving into another place, both of which involve many moving parts -- some of them quite expensive.

For starters, you have closing costs on your new home: legal fees and land transfer taxes, which vary from province to province, plus utility setup costs. In Toronto, homeowners pay provincial land transfer taxes and municipal land transfer taxes.

If you can't cough up a 20 per cent down payment on the new home, you'll have to pay for Canada Mortgage and Housing Corporation (CMHC) mortgage loan insurance. The fees depend on your mortgage; a 5 per cent down payment would come with a 3.15 per cent fee tacked onto the remainder of your mortgage. Provincial sales tax (PST) is added on top of that in some provinces, a cost you must pay upfront. A $5,000 CMHC insurance fee would come with a $400 PST bill, depending on your province.

A brand-new home comes with Harmonized Sales Tax (HST) in five provinces, which varies from 13 to 15 per cent.

Finally, real-estate fees are a one-time cost that comes with selling your home, and they eat up between 2 per cent and 6 per cent of your sale price. Home inspections and appraisals typically cost between $150 and $500 each.

Heath gives an example: say you're a family with a $500,000 home looking to downsize to a $400,000 home. Out of your $500,000 sales price, you'll pay real estate fees of $25,000, followed by $28,000 in HST fees, and another $8,000 in land transfer taxes. That's already more than half of the savings from the downsize.

These costs don't even include moving costs: hiring movers, buying moving supplies, and taking time off work for your move. They also don't include sprucing up your current home for showings or having repairs and maintenance done to make it more appealing.

"Downsizing may be beneficial and may be helpful but you need to take into account these transaction costs," Heath says. "They'll add up."

Make sure your housing expenses are the problem
Based on the laundry list of expenses involved in downsizing, consumers need to carefully consider if their housing costs are the culprit that's causing their debt.

"Downsizing may not actually be the answer to your debt problems," says Tom Feigs, a Calgary-based financial coach with Money Coaches Canada. "It's better to understand your personal cash flow before making that decision."

Scrutinize your costs, starting with fixed expenses, such as your mortgage, utilities, insurance and property taxes. As a rule of thumb, the CMHC, which oversees the nation's housing strategy, says you shouldn't be spending more than 32 per cent of your gross household income on housing costs.

Statistics Canada says most Canadians who are overspending on housing costs overspend by $510 -- it's easy to see how homeowners could end up in house-poor territory.

But you also need to factor in your discretionary spending. Feigs suggests that families carefully document their spending on groceries, gas, dining out, gifts, vacations and all other discretionary spending. You might learn that you can afford your home but you're overspending in other categories, he says.

"[Downsizing] might not fix the real problem if the real problem is not being aware of your cash flow," he explains.

Finally, ask yourself if you're dealing with one-time debt or an expensive phase in your life. Maybe you had a leaky roof or you have three young kids who need daycare. If that's the case, it could be worthwhile to crunch numbers and create a reasonable plan to pull you through those expensive years without resorting to downsizing.

Keep in mind, too: if you're downsizing to a home further out of the city core, you'll be compensating with higher transportation costs or longer after-school care for your kids.

Explore other options, if you have to
Heath says that he encounters clients who know they may have purchased too much house but refuse to downsize.

"There's a certain sense of pride, financially speaking, that comes with owning a home," Heath says. It's also hard to take your kids away from their childhood home, school and friends, he notes.

In that case, consider making sacrifices in other areas: taking on a second job, renting out the basement or simply trimming down the budget until you can make ends meet comfortably.

See related: 5 smart financial moves for low-income seniors, How to choose the right credit counsellor

Published March 6, 2015

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