Home ownership is often a process. You buy your first, relatively modest home, build some equity, and then after a few years move up to a nicer, more expensive one. But how do you arrange financing to buy that new home when you’re still making mortgage payments on the old one?
Upgrading to a new home used to be fairly easy. The equity and credit history you built over several years of owning your first home made you an attractive prospect for lenders who were willing to offer flexible financing to help ease you through the transition from one home, and mortgage, to another.
But in today’s tight-credit marketplace, that’s much harder to do. So how do you juggle the handoff between buying a new home while selling your old one?
You could always sell your present home and rent a place to live while you’re looking for a new one. However, many people would prefer a more seamless transition, not to mention avoiding the inconvenience of moving twice while putting some of your goods in storage.
Here are a few other options to consider:
If you can swing it and seller will allow it, a contingent offer is the most straightforward way to make the transition from one home to another. The way it works is you make an offer to buy the new home contingent on selling your old one. Once you sell your old home, you close on the new one with the proceeds from that sale.
Home equity loan
Another option, if you have significant equity built up in your current home, is to apply for a home equity loan to use in funding part of the purchase of the new one. Then when you sell the old home, you can pay off both the home equity loan and the old mortgage as well.
The challenge with this option is that you have to qualify with both homes. That is, the borrower must be able to show they have enough income to handle the monthly payments for the home loans on both houses at once.
Since lenders typically don’t want to see borrowers spending more than 45 percent of their monthly income on debt of all kinds, that can be a tough standard to meet. In addition, when applying for the home equity loan you have to be upfront with the lender and let them know you plan to vacate the property and buy a new home. That will raise the cost of the home equity loan, but to fail to disclose such plans would constitute fraud.
Tapping a 401k
Another popular option is to borrow down payment money from a 401k retirement plan, then repay the account once you sell. This is allowed without penalty under federal law, although the rules vary among individual 401k plans. Check the “terms and conditions for withdrawals” on your 401k to see what’s allowed on your plan and if there are any additional costs involved. In most plans, you have 60 days to pay the loan back without penalty.
Just like with using a home equity loan, however, you’ll still have to get qualified to carry both your old and new mortgages simultaneous. Depending on how much you can temporarily draw out of your 401k, though, you may be able to whittle down the size of the mortgage on your new home enough so that it’s not that high of an obstacle to meet.
Rent it out
If you can’t use a contingent offer, and you can’t qualify for carrying two mortgages at once, you might consider turning your old home into an income property by renting it out. That way, your lender will count the rent you’re receiving as income to help you qualify to carry both mortgages.
To do this, however, there may be stipulations based on the loan program you are getting for the new house. If you securing conventional or FHA financing, in order to count the rent to offset your current mortgage payment, you must have at least 30 equity in the home. You will also need to have a renter lined up, minimum 12 month leases signed and have collected first month’s rent and a security deposit equal to one month’s rent before you close on the new home. You can’t simply tell your lender that you’re planning to rent the property and expect them to qualify you on that basis.
If you are utilizing a VA home loan for your mortgage, the 30% equity requirement is removed.
This can be a great option, especially in light of how great the rental market is currently.
The FHA option
Another possibility is to buy the new home with an FHA mortgage, then refinance it into a less-expensive Fannie Mae- or Freddie Mac-backed loan after the current home is sold.
The benefit to the FHA mortgage is that it only requires 3.5% down and the Debt to Income qualifying ratios are much higher. So that provides a possibility for someone to qualify to carry the payments of two mortgages, but either cannot or is unwilling to put up a large down payment.
Down payment assistance
A final option for certain types of buyers is to look to federal or state programs that offer down payment assistance. Although these are usually aimed at first-time buyers, some of them are also available to repeat buyers in certain income brackets who are looking to buy a different home in a qualifying area.
The availability of such assistance and rules vary from state to state, so check with your local lender.
One to forget – for now
Bridge loans, a type of short-term financing that extended credit for buying your new home on the expectation you’d soon be selling your old one, were quite common before the crash. They were also a fairly costly type of credit. But these days, they’re pretty much extinct. There isn’t a viable Bridge loan product available right now, however, as the market changes and lenders once again feel confident making such loans, there could be a future again. But for now, they’re pretty much off the shelf for residential mortgages.