One of the most common questions we receive is how do I make best use of the equity in my existing home when purchasing another home? Sounds like an easy question . . . . Sell your existing home and then use the proceeds as down payment on the one you want to purchase! Seems pretty simple but there may be just a bit more to it than that. As our market continues to be very strong and Consumer Confidence hits a 16 year high, writing an offer on a property to purchase contingent on the sale of your existing home will not be nearly as competitive of an offer as it would have been even a few months ago. It also sometimes leads to a rushed sale to complete the contingency and potentially sacrificing some of that hard earned equity to accomplish the end goal.
The other alternative, selling your existing home and then closing on the one you want to purchase has a couple of significant snags in the way as well. First and foremost, it means that you have to move twice. This is almost impossible to avoid on the purchase of a new home, unless it is a spec home, simply because the end property is not readily available to close simultaneously. This is one of the many important reasons, you should take us with you when shopping for a new home. Our advice can keep you out of some uncomfortable and foreseeable problems.
Moving twice in a transaction for some people is a fate worse than death and for others it appears to be no big deal. Many of our military families are quite accustomed to moving and so the double move does not add another level of stress. For others, moving twice is an absolute death nail. With the pod systems available today, at least moving to temporary housing is mitigated somewhat and we can usually find temporary housing for our clients.
If you want to avoid either of these two scenarios, the first determination that must be made is whether or not you can qualify for both loans or not. It is still a widespread misnomer that if you rent your existing home the income will offset the monthly payment for qualifying purposes. The criteria for this is quite extensive but essentially, the rental income either has to be listed on a prior year’s tax return OR you must show proof of the deposit, first months rent AND 25% equity in the home. This amount of equity must usually be verified with an appraisal on the existing home.
Many of my clients, because they have large amounts of equity in their existing home (meaning low mortgage balances) and have lived in their existing home for a long time (meaning their incomes have grown and creditworthiness improved) are able to qualify for both loans. This certainly solves the moving twice problem. It also still leaves open the question of transferring equity.
So if you do qualify for both loans without any other conditions, you still have to satisfy the problem of down payment and closing costs for the new purchase. With a VA loan, of course this does not present a problem. Remember, you can’t have two VA loans (unless you are both veterans) so if your existing loan is a VA, you will have to use another vehicle to finance the purchase. These other vehicles such as FHA and Conventional offer down payments between 3.5% and 5% as a minimum but both carry large mortgage insurance premiums which is one of the things your are trying to avoid by transferring your equity.
Here are a couple of strategies that may accomplish the end goal without having to either move twice or pay large mortgage insurance premiums. Let me stress that none of these address the payment stress of having two mortgage payments. You must rely on the ability of a good agent to ensure that once you embark on one of these avenues that they can actually get the existing home sold after the fact. Borrowing from a 401k: Many 401k program allow you to borrow or withdraw funds from them to complete the purchase of a home. While this may not be a good long term investment strategy, in the short term this may solve all of the problems of moving twice, paying higher mortgage insurance and really has no effect on your loan qualification other than if those 401k assets were being used as reserve funds for the mortgage. This option is very viable and preferred. The only two down sides to this strategy are that in some cases it can take up to 90 days to obtain those funds and also it is very important that all of those funds are paid back to avoid any tax penalties for early withdrawal. You should ensure that there are no tax consequences BEFORE you proceed down this path. Home Equity Line of Credit: This method may actually be simpler overall. It is quick and relatively easy to obtain a line of credit on your existing home. It can usually be accomplished in a few weeks. You simply have us over to determine the approximate net proceeds from your home and then obtain a line of credit for that amount. You then utilize those funds for the down payment and closing costs on the home your are purchasing. A month or two later when your existing home sells, the line of credit is paid off and you have successfully transferred your equity with very little costs to you. The major down sides to this method is that some people borrow the maximum they are allowed on the line of credit and then the proceeds of the sale are insufficient to pay off the line of credit. Another issue is that this additional debt may affect the qualification process for the new purchase as opposed to the 401k solution where you are borrowing from yourself. Just refinance after the fact; The simplest of all these methods if you qualify for both loans and the one with the most quantifiable risk is to purchase the home with one of the lower down payment programs and then once your existing home sells, pay that equity down on the mortgage and refinance the entire mortgage. Of course this costs money! Generally 2.5-3% of the NEW loan amount after the equity has been applied. This is a significant amount of money but it is a known amount and therefore the cost-benefit can be evaluated on known information. Adjustable rate mortgages: If you have an affinity for adjustable rate mortgages this also solves the problem. VA, FHA and Conventional all offer adjustable rate loans that in most cases do better than fixed rate mortgages. They all have one very unique feature. The payment amount is recalculated based on the remaining balance. This means that should you close on your new purchase and then sell your old home, then apply the equity to the loan balance, the payment will be recalculated based on the new balance effectively solving all of these problems at once. If you need help navigating the complicated areas of finance and real estate in todays ever changing market, give the Al Gage Team a call at 623.536.8200 or email us at al@algage.com