The two traps of ‘unlocking money’ by downsizing your home

Downsizing is a popular planned approach to fund retirement fun. The dream might be to swap the big family home you are rattling around in to rattle around the world a bit … and base in a lovely little unit, maybe with a view.

But the plan has two – opposite – enormous pitfalls.

Let’s look first at if you sell and pocket profit, before we get into what instead usually happens. The government is trying to encourage downsizing to free up some housing stock with the relatively new ability to shelter $300,000 of your sale proceeds in the tax-advantaged super environment.

This is a big opportunity – the only real restriction is that you need to be aged 55 or over.

Other than that, you are eligible if you sell a main residence you have owned for at least 10 years. And you can put the money into super even if you are older than 75 (usually when voluntary contributions need to cease – you just have to pay the money into super within 90 days of sale and fill out the downsizer contribution form and give it to your super fund within that same time frame.)

It’s $300,000 for each owner, too. Happy days, that’s $600,000 in profit for a couple. But using that strategy means the $600,000 that used to be exempt from the assets and income test for the aged pension is now counted.

And that’s possible pitfall number one. Even if “successfully” executed, your downsize will unlock money for you to live on but may lose you government money in the form of a pension. You need to do the numbers carefully.

But you also need to do your property market research assiduously because I have seen instance after instance over the years where people who intend to downsize instead “up-price” – probable pitfall number two.

Even if you are prepared to sacrifice space, which is often unappealing at (literal) crunch time when you are used to the larger proportions of a house, you’ll probably want to compensate with outlook. And an expansive outlook is – you guessed it – expensive.

So a bunch of products have sprung up to release the money that is tied up in your home without selling. To have your cake and eat it too, if being able to afford to eat is the issue. The main commercial equity extraction options are the reverse mortgage and home reversion scheme.

They can form a valid plank of a retirement strategy and have done so for decades in places such as the United Kingdom and the USA. With a reverse mortgage, you take out a mortgage over your home on which there are no repayments.

Instead, the interest rolls up, and the end debt is repaid from the proceeds of the sale of that home either when you die or decide to sell (you may be able to pay it out from external funds too – check). As the debt carries no periodic repayment and has no time limit, the interest rate is expensive, at a full percentage point or more above a regular mortgage.

A home reversion scheme offers an alternative option. Here, you straight-up sell a chunk of your house to a product provider, which will then get that same chunk of the sale proceeds.

Both carry the guarantee that you can’t get kicked out before you, well, kick the bucket. But extracting money from your home, however you do it, still presents that possible pension-eligibility problem.

A third option that is more favourably treated for pension purposes is the Services Australia Home Equity Access Scheme. This is like a reverse mortgage in that, if you’re eligible for a pension, you may be able to borrow against the equity in your home to supplement your retirement income.

This carries a much cheaper interest rate than a reverse mortgage, with the downside of strict limitations on what you can borrow. Whatever flavour of equity extraction you opt for, though, you still need to maintain your home in fully functioning order.

Which brings us full circle back to downsizing and the ultimate desire – perhaps – to prioritise lifestyle over painting the walls. You could perhaps buy somewhere with a body corporate to take care of the upkeep for you – maybe that’s the dream.

Just heed my earlier warning about the potential property price blowout. And don’t forget to account for not just body corporate but any possible special levies or large, one-off fees.

Nicole Pedersen-McKinnon is the author of How to Get Mortgage-Free Like Me, available at www.nicolessmartmoney.com. Follow Nicole on Facebook, X and Instagram.

Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.