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Illustration of a big cake in the form of a house being cut by a knife
Kiersten Essenpreis for Money

When Linda and Gary Hansen downsized in 2014, they made out pretty well. They sold their 3,300-square-foot St. Louis home for $325,000; trading down for a 1,900-square-foot house in Largo, Florida — and banking about $40,000 in the process. They paid in cash, so there was no new mortgage payment to worry about, and got to achieve their dream of retiring by the beach. (Their house is a mere two miles from the coast).

“I never wanted to be cold or see snow again,” Linda says. “I tell people that the only thing I want to see that is white on the ground is white sand.”

But that was eight years ago. Now, their Largo home — which they paid $288,000 for — is worth more than double that. And their goal of downsizing by the beach? Linda says that wouldn’t be possible with today’s inflated prices.

“Now with the insanity of Covid, our home would be worth around $625,000,” she says. “We would not be in a position to buy it now.”

With home prices up a jaw-dropping 19% in just the last year, downsizing isn’t as affordable — or profitable — as it once was. Which begs the question: Is there still financial gain in selling big and buying small?

It’s possible, experts say, but today’s market might pose some challenges. Are you considering cashing in on your home’s equity and buying down? Here’s what to think about before you do.

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High home prices

Skyrocketing home prices are the first hurdle today’s downsizers have to deal with. Unlike in the Hansens’ time, most markets don’t have sub-$300,000 homes readily available (the median national home price is now well above $400K).

Prices in Sun Belt states — popular retirement spots for seniors — are even higher. In Orlando, the median home price is now $450,000 — up 32% from last year. Over in Miami? It’s $627,000 — a whopping 46% increase.

“You’re arguably going to be selling at the top of the market, and you’ll get the most profit possible for the property you own today,” says Scott Lindner, national sales director at TD Bank. “But on the flip side of that, while you’re looking to make your new, downsized purchase, you’re going to spend a premium for the property — even if it’s smaller.”

Smaller homes also come with intense competition. Housing inventory is strapped, and since most first-time homebuyers are vying for homes with modest square footage, that translates to bidding wars and — surprise, surprise — even higher prices on these smaller-sized properties.

The typical house that went under contract in March was just 1,720 square feet, according to a report from real estate brokerage Redfin, condos and townhomes — other top choices for downsizers — are also becoming more popular.

“Whatever smaller home you choose to buy will likely be much more expensive than it would have been otherwise,” says Rebecca Awram, mortgage advisor at Seniors Lending Centre. “So, you're getting less value for your dollar.”

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Pricy moving costs

There’s also inflation to contend with. With U.S. inflation at 40-year highs, virtually everything involved in a move will be more expensive — supplies, storage, movers, truck rentals and, of course, the gas needed to haul your stuff to your new home.

“When you downsize your home, you may need to downsize your furniture as well — whether it’s replacing a sectional with a smaller couch or a king-sized bed with a queen-sized bed,” says John Fischer, enterprise lending executive at Bank of America. That, coupled with expenses like real estate agent fees, means “Moving costs can add up fast,” he adds.

Capital gains taxes are another sizable cost you might have to contend with. Per IRS rules, you won’t owe taxes on your home’s sale proceeds if they’re under $250,000 (if you file your returns solo) or $500,000 (if you file as a married couple). If you do make more than these amounts when selling your home, you’ll owe as much as a 20% capital gains tax on the profits — or $40,000 on a $200,000 gain.

In a typical housing market, these are easy thresholds for most sellers to fall under — but with today’s inflated home values, not so much. Robert Elson, a real estate agent with Coldwell Banker Warburg, recommends estimating all these costs in advance — well before you decide to downsize.

As he puts it, “Downsizing could be the right path for seniors who want to live out their golden years with more money in the bank, but not always.”

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Rising mortgage rates

Unless you have the cash to buy your new home outright, downsizing might not be worth it financially. Mortgage rates have jumped more than 2.5 percentage points since the start of the year, and financing a home purchase is now significantly more expensive than it was just a few months ago.

According to Freddie Mac, today’s average rate is 5.78% on 30-year loans. On a $400,000 house, that’d equal a monthly payment of $2,341 and a whopping $443,000 in interest costs over the loan’s term.

“If you have a mortgage on your current home and are looking to finance your next one, keep in mind that rates have gone up and the rate you would get could be higher than your existing one,” says Rob Heck, vice president of mortgage at Morty. “While downsizing may present some savings, you have to weigh this against the interest you’ll pay over time — particularly if you have a fixed income as a retiree.”

More than the costs, though, Heck says you should also consider your ability to qualify for a mortgage.

“Many retirees find it harder to get home financing in retirement because they are unable to show the stable income stream that lenders are looking for,” Heck says. “Conventional and government mortgages are typically underwritten based on income, not assets.”

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Downsizing done right

Downsizing can certainly come with emotional and personal benefits, but with current economic and housing conditions, the financial perks are harder to come by.

“In today’s market … it might not be advisable to [downsize] right now but wait for interest rates to settle and for housing inventory to increase over the next couple of years,”says Kimberlee Davis, managing director and partner at wealth management firm The Bahnsen Group.

If you do opt to downsize this year, carefully consider the market you buy your smaller property in. Look at housing indicators — home prices, competition, number of listings, etc. — as well as cost of living and local property tax rates.

“Moving to an area where your property taxes are lower could help free up room in your monthly budget,” Heck says.

There are alternatives to downsizing too. You could sell your home and move into an RV (though high gas prices may pose a challenge), or you could lease out your home and move to a rental in your dream retirement spot. Both would allow you to avoid the high home prices and mortgage rates today’s market comes with.

“If you make a profit on your house sale, you can invest the proceeds and that can help with cash flow in retirement,” Davis says. “It also may give you the flexibility to travel with less worry about property maintenance.”

If you need extra cash, home equity loans, HELOCs and reverse mortgages are also options. Just make sure you talk to your financial advisor or tax professional before pulling the trigger.

More from Money:

Why Home Sellers Prefer Cash Offers — Even if They're Lower Than Competing Bids

4 Tips to Avoid Overpaying in Today's Changing Housing Market

Stressed and Alone': Homebuyers Are Turning to Therapy to Cope With a Wild Housing Market