In the past two years, many buyers purchased property with low down payment programs and have seen a substantial rise in their home equity, creating an opportunity to upgrade to a more desirable home and/or neighborhood. Perhaps the family is expanding, or the timing is right to trade up. As enticing as this sounds, due to the tight lending environment, taking the right steps should be the main focus. Let’s look at how to pay off one house, and use the net proceeds from the sale to purchase another, and still qualify.
Lenders are still restrictive on debt ratio, most allowing no more than 45% of your monthly income, and changes in January 2014 will limit this number even further to 43%. The reason most homeowners sell one house in exchange for another is because they don’t have enough income to carry two mortgage payments, don’t want to be a landlord renting the property or they need the equity for the down payment.
Whatever the circumstances, here are some important aspects to consider.
Get pre-approved. Have the lender pre-approve you as though your current home is already sold. By having the lender omit your present liability, your projected debt ratio is reduced, making you look better on paper. This pre-approval may even include the down payment coming from the sale of your current home. Certainly the numbers can change, but by doing the homework upfront, you can have a better depiction of how the numbers will pencil.
Use a realtor. Get professional real estate representation. Your listing agent can represent you on the buy side on your new property, facilitating a successful and smoother process for both transactions because they can communicate with the other agents as the intermediary, solidifying both sales through the close of escrow.
Make a contingent offer to buy. Real estate professionals know a contingent offer — that is, one property selling in exchange for being able to perform another — is weaker than if there is no contingency. While this is certainly true, contingent offers are becoming more common.
Releasing financing contingencies at the same time. This is a crucial aspect to the real estate contract. In most real estate contracts, you fully commit yourself to purchasing the property at 17 days. During the first 17 days, it’s expected of you as the homebuyer to make sure your lender has loan approval. After your loan is approved, release your contingency at the same time the buyer of your home releases their contingency, that way you don’t release contingencies on a property, risking the possible forfeiture of your initial earnest money deposit if the buyer of your property can’t perform.
Q & A: How to Upgrade to a Pricier Home
Q: I have a home that I purchased in 2011 for $350,000 with an FHA loan. I put 3.5% down and I want to sell that house to purchase the new one for $525,000. How would the math workout?
A: Let’s assume the house you purchased in 2011, is now worth $470,000, and that after paying your real estate agent and paying off your loan, your net is $118,500. This $118,500 net is just a little more than 20% down on a new sales price of $525,000. Good news is that, by putting down a minimum 20%, it becomes elective to have monthly property taxes and insurance built into your payment and you will not need monthly mortgage insurance assuming a conventional loan.
Q: Can I rent out my home instead?
A: Yes, so long as you have 30% home equity in that property or more, indicated by an appraisal required by the lender who’s handling your new home purchase. If the plan is to rent out your current home, so the liability is offset by rental income, the down payment for the new property will have to come from some other source, such as gift funds or your own cash.
Finally, there is a critical component when it comes to buying one home in exchange for selling another. If you’re securing mortgage loan financing, make sure that the lender who is doing your initial pre-qualification knows how much you anticipate netting from the sale of your current home, and subsequently pre-approves you for the sale of the new home by omitting your current housing obligation. Some lenders have stipulations, so be sure to do the proper research.
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