Homeowners sell their homes and buy other homes for a variety of reasons including a need to live closer to a place of employment, to be closer to family, to enjoy a better climate, or simply to upgrade. This article is about finding the best sequence of steps in the process.
The Importance of Equity In the Existing House: Whatever the reason for the planned exchange of houses, the amount of equity the owner has in the existing house is often critical. It may determine whether or not the exchange of houses is feasible, and if it is feasible, on the best way to sequence the two transactions.
The equity available in existing houses for use in purchasing other houses peaked in mid-2006 with the onset of the financial crisis, dropped sharply over the next 6 years, and has since come back but not entirely. Data from CoreLogic indicate that about 10% of all mortgaged homes still have loan balances in excess of property value.
This widely cited statistics on underwater loans actually understates the drag of inadequate equity on sale/purchase transactions because of the high cost of selling a home. More relevant is what might be termed "useable equity", which is the property value less the existing loan balance, and less the sales commission, transfer taxes and any other transaction costs.
Minimizing Inconvenience Means Buying First: The least burdensome way to make the switch is to retain access to your existing home until such time as you move into the new one. If you vacate your existing home first, you have to find a place to live while you wait, and a place to store furniture and other effects. This can be a hassle. Whether or not you can successfully buy before you sell depends in good part on your financial situation.
Enough Income and Cash: In the most favorable situation, you have enough income to carry two mortgages; and enough cash to meet the cash required to purchase the new house without having to use any of the equity you have in the old one. You would contract to buy your new house first, and arrange for the mortgage you need to effect the purchase. You then put your old house on the market, setting a closing date beyond the closing on the new house. That way, you can stay in your old house until you are ready to move into the new one.
Enough Income, But Not Enough Cash: In a less favorable situation, you have enough income to carry two mortgages, but not enough cash to close on the new one. You need to cash-out some of the equity in your existing house.
The simplest way to get it without selling your existing house is to take out a home equity line of credit (HELOC) on that house. Then, you have the same flexibility as in the first case. You can take whatever time you need to find the house you want to buy, following which you sell the old house and pay off both mortgages. Two articles on my website will tell you want you need to know about HELOCs: What Is a HELOC? and How Do You Shop For a HELOC?
Warning! Take out the HELOC well in advance of your purchase, leaving all or most of the line unused until you need it, and before you put your existing house on the market. Lenders don't appreciate HELOC customers that pay off fully within a short period.
An alternative to the HELOC, which is simpler and cheaper, is a short-term loan from a bank, called a "bridge loan", but it requires that you have an unconditional contract of sale on your existing home. The loan bridges the period between the closing on your new house purchase, and the closing on your existing home sale; it is repaid when you sell. The lender's requirements for a bridge loan are much the same as those imposed by the mortgage lender who finances the home purchase, as described below.
Not Enough Income or Cash: In the least favorable case, you don't have enough income to carry two mortgages, or enough cash without the equity in your current house. This means that you must sell before you can buy, and the new lender will want conclusive evidence that this will happen before processing your application.
The lender will want to see an unconditional contract of sale that has no escape clauses for the buyer, such as a mortgage contingency clause. Many lenders will also require a significant non-refundable deposit by the buyer. And the sale must be a done deal before the new mortgage will be closed.
In this situation, the only way to avoid having no house in which to sleep is to close both transactions on the same day, with the sale transaction occurring first. That may or may not be feasible.
For more information and unbiased advice on forward and reverse mortgages please visit my website The Mortgage Professor.