“Inflation has been much more rigid than people originally thought,” says Connor Spiro, senior financial consultant at John Hancock. “I think we’re still going through 2022 and even into 2023 you can see it’s going to be longer than initially thought.”
Typical budgeting advice focuses on cutting back on day-to-day discretionary spending such as streaming services or dining out. Such moves can be difficult to sustain, and they may not generate enough savings to make a long-term difference.
If you’re ready for a more aggressive strategy, it might be time to look at your biggest budget items — your rent, car payments, or mortgage — to see if it’s time to downsize.
Making a significant change to these expenses could yield significant savings – more than enough to sustain a lifestyle that allows for more discretionary spending. That said, downsizing also requires big lifestyle changes, like moving to a smaller house or an area with a lower cost of living or trading in a luxury car for a standard model.
The challenges of downsizing now
While in years past downsizing might have been a no-brainer for people looking to drastically cut spending, rapidly rising interest rates have complicated the math. If you’ve locked in a low mortgage rate for the past few years, your monthly payment could be lower on your current property than if you moved to a cheaper property with a mortgage at current rates.
“In this economic environment, it’s important to think about what you’re going to cut,” Spiro says. “Are you looking to downsize and buy another property, or are you looking to downsize and rent? They are two completely different financial paths.
If you are renting, recent inflation can make it difficult to find significant savings unless you move to a less desirable location. Given these possibilities, it’s important to crunch the numbers if you’re considering downsizing to see exactly how much you could save and if it’s worth it to you.
Rising car prices also mean that it may be better to keep an older, higher-end car than to trade it in for a newer, cheaper model. However, if you are nearing the end of a lease, you may be able to make some money by buying it out.
Your situation matters
Many factors should be considered before making the decision to downsize, including your current and future income and life changes, such as if you plan to get married or expand your family. Your life stage is also an important consideration.
“If you’re 25 and paying almost all of your income in rent and you can’t put money away for retirement or saving in an emergency fund, you may really need to start ask if this rent is too expensive for you. says Isabel Barrow, director of financial planning at Edelman Financial Engines. “But if you’re a recent retiree sitting on a big property without a really big mortgage, and you’re trying to decide whether to downsize now or wait a few years, there might be other ways to cut your expenses. Right now, that makes more sense.
If you locked in most of your fixed expenses before inflation took hold of the economy, you may be in a better position than you think. A rule of thumb to consider is that your housing costs should be no more than about a third of your take home pay.
“In many cases, people worry unnecessarily,” Barrow says. “If you have a fixed mortgage and a fixed car payment and good health insurance, even if groceries are a bit more expensive, you’re not necessarily in a position where you have to restructure your whole life.”
While downsizing may be a solution for some people struggling with inflation, the current economic environment means it’s a tougher decision than in the past. That said, taking a close look at all of your expenses — especially those that make up the bulk of your budget — is always a good way to keep your finances on track.
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