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Annual Retirement Guide July 3, 2008, 5:00PM EST

Choosing Where to Grow Old

Remodeling your home is enticing—and hugely popular. But a smaller home might be preferable, or even a granny flat with your kids. Be wary, though, of reverse mortgages

by Chris Farrell

As Jane Austen wrote in Emma: "Ah! There is nothing like staying at home for real comfort."

Problem is, many people's homes—their most valuable asset and the foundation of their retirement plans—are providing scant comfort these days. The Standard & Poor's (MHP)/Case-Shiller 10-city home price index is down 16.3% on an annual basis, and the 20-city version is off 15.3%. Adding to the financial stress are the bigger debt burdens many families carry in their near-retirement years, including hefty mortgages and home equity loans.

It's hard enough under normal circumstances to figure out how much is needed to ensure a comfortable retirement. But the mix of slumping housing prices, oil at around $140 a barrel, and volatile financial markets makes it particularly tough today. With energy analysts increasingly convinced that high oil prices are here to stay, and stock and bond markets expected to remain under pressure, living plans may need to be rethought. At the very least, assumptions about how much a home will appreciate need to be reexamined. Largely because of the drop in housing prices, the median household wealth of homeowners aged 45 to 54 will have fallen by 25% between 2004 and 2009, project economist Dean Baker and research associate David Rosnick of the Center for Economic & Policy Research. Even America's wealthiest 20% will have seen their balance sheets plunge by 27%.

At some point, of course, real estate prices will stabilize and economic growth will pick up again. The question, as always, is when—and by how much. Until the smoke clears, the twin pincers of rising costs and volatile stock prices may persuade an increasing number of older Americans to think about coming up with a Plan B for their housing needs in retirement.

The most practical approach is simply to downsize, suggests Henry K. "Bud" Hebeler, author of Getting Started in a Financially Secure Retirement (Wiley & Sons, $19.95). That's not a very popular choice, however. "We find that downsizing is the ideal in many cases, but it's not the norm," says Ross Levin, a certified financial planner and president of Accredited Investors in Edina, Minn.

One reason may be that families often find that a smaller home doesn't come with a much smaller purchase price. A two-bedroom condominium in an attractive part of a city with all the amenities typically sells for nearly the price of a comfortable four-bedroom home in a tony suburb. "People don't save money on the purchase price by going from 2,500 square feet to 1,700 feet because they [still] want the granite countertops and the Jacuzzi tub," says Joel Larsen, a certified financial planner with Financial Strategies Group in Davis, Calif.

But Hebeler—a former president of Boeing's (BA) aerospace unit and the founder of analyzenow.com, a financial advice Web site—notes that large homes cost a lot more to maintain and are subject to higher property taxes. The savings from running a small home compound over time. Plus, as we age, few of us want to perform maintenance. Smaller yards and single-level homes become more attractive, as do condominiums and townhomes with maintenance staffs.

Downsizing could become more common as energy costs rise and the population ages. Hebeler advises anyone contemplating a smaller residence to act sooner rather than later. "I believe that over the next decade, small homes are going to be relatively pricier than large ones, at least on a dollars-per-square-foot basis," he says. "Smaller homes will be in more demand, and many larger homes will be on the market."

Still, many people are reluctant to move out of their current digs. "Since most people want to stay in their home, they need to look at how feasible that is from the point of view of long-term care," says Larsen. This often means changing the first-time home buyer's catchphrase of "location, location, location" to the aging homeowner mantra of "remodel, remodel, remodel."

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