The Chicken/Egg Conundrum of Real Estate
This post, contributed by Marc Aymard (a preferred lender) is not really about chickens and eggs… it’s about how to sell your current home and buy the next one, all at the same time….
Having the flexibility to purchase a new home without the sale of your current home has some distinct advantages, even if you plan to sell your current home at the same time as your purchase.
In our local market, home inventories remain low and many properties receive multiple offers. When competing with other buyers, you need to position yourself as having the most attractive offer in the eyes of the seller. If you own your current residence, that means making your offer non-contingent on the sale of your existing home. Needless to say, there is some risk in this strategy (i.e. carrying two mortgages at the same time) but it can make the difference in getting the house you want.
If you are really lucky, you may find a seller willing to give you a specific period of time to sell your home and if you are not successful, it will void the contract without penalty to you. This is called a home sale contingency. Most sellers are unwilling to give you this protection because they take their home off the market without a guarantee that you will buy the home.
To avoid this predicament, talking with a lender to determine if you have the flexibility to buy without selling is a smart idea. There are two primary questions you need help getting answered:
- Can I qualify carrying both mortgage payments?
- Where do I come up with the down payment for my purchase prior to receiving proceeds from the sale of my current home?
Qualifying Carrying Two Mortgages
Unless you sell your current home prior to purchasing a new property, lenders must count the carrying costs for both homes in your debt ratio calculation. Even if you have a buyer under contract to purchase your current home, you can no longer discount that mortgage payment. The good news is that certain loan programs allow borrowers with good credit to carry a very high debt load (as much as 55% of their gross salary in some cases). Granted, you probably won’t feel comfortable carrying such a high debt load long term, the point is you may have more flexibility than you thought.
If you intend to keep your existing home and rent it to a tenant, you may be able to offset the current mortgage payment with a percentage of a new lease amount. In order to do this, you will need to document, through an appraisal, that you have 25%-30% equity in the home you intend to rent. If you have less than 30% equity in your home, lenders may not recognize the income generated from renting the property until you have rented the property for at least one year.
The Downpayment Dilemma
Once you have determined that you can carry both mortgages, the next step is raising the funds for a downpayment.
- The first thought most borrowers have is a bridge loan. Bridge loans are temporary financing on the home for sale; however, these are essentially non-existent in today’s lending environment. Only a few lenders offer a bridge loan option and they may charge a significant fee for the loan.
- If you have an unused equity line on your current home, this can be a very simple solution if the equity line is big enough.
- Another option is to consider a loan against a retirement plan, such as a TSP or IRA. Most retirement plans have a modest limit on the amount you can borrower regardless of the amount you have invested – usually around $50,000. You will want to ask your plan administrator about any tax penalties and whether or not your money remains invested.
- Obtaining two mortgages for your purchase is an effective strategy as well. The first mortgage is set for the amount you want to keep after the current house is sold and the second mortgage for the remainder. This is a great alternative, but you will still need to find a 10% down payment from other sources. Like a bridge loan, this loan structure is hard to come by and can have very restrictive qualification guidelines. You may need to do some research to find a lender with this solution.
- If liquid funds are very tight, you might consider a low downpayment option such as an FHA loan with the intention to refinance after your home sells. This is probably the most expensive option due to the costs of refinancing, but in some cases may be worth it.
- Gift funds from a family member are acceptable in most cases.
Some solutions that are generally not acceptable include loans from your business, unsecured loans or gifts that require repayment. You must also be very careful to report to your lender – early in the process – how you are getting your down payment and what, if any, repayment terms there are. Using that equity line of credit will further increase your debt load, and that debt must be calculated when you’re being qualified.
If you determine that an option to carry both homes does not exist or it exceeds your personal risk tolerance, you will want to focus on options within the contract. This is where an experienced and skilled Realtor is crucial.
The bottom line is that if you are planning a move up purchase, doing a little legwork early in the process with a good lender and Realtor can save you a lot of heartache.
………………….Post Contributed by Marc Aymard, Branch Sales Manager for a local lender in Fairfax, Virginia.