Americans are quite mobile. Recent statistics show that we move every 5 years, on average. Job relocation and the need for a larger home are the most common reasons, with most moves occurring within the same state. Most homeowners will begin their life of homeownership with a starter home, which is a great way to build equity in preparation for their next—most likely larger—home. The cycle continues until they reach retirement, when retirees look for a smaller home or even to rent.
Unless you’re paying with cash, you will need a mortgage to purchase your next home, and you may face the prospect of having 2 mortgages at once. Here are the 3 most common home-transitioning scenarios, with tips on how to make this upgrade doable.
Option 1 – Buy your new home, then sell your former home
This is the simplest and easiest way to transition to a new home, but it requires that you have income (and lack of debt) to support 2 mortgages and that you have money for the requisite down payment. Remember that your debt-to-income ratios (DTIs) include all of your debt payments, including your current mortgage, even if you plan on selling your home. Lenders have to assume that you will have that payment indefinitely, so they include both of the mortgage payments in their DTI calculations. If buying a home was tight before and your income hasn’t increased substantially (or you’ve added significantly more debt), qualifying with both mortgage payments could prove quite difficult.
Tips – Income qualification
· Consider an FHA loan – FHA loans allow for significantly higher DTIs. You can even have 2 FHA loans at once, under certain circumstances, or if it’s contingent on you selling/refinancing the other home.
· Pay down other debt – This requires some planning, but credit cards and car loans have significantly higher payments compared to their balances than mortgages. Paying down $8000 in credit card debt could give you an extra $30,000 in home-buying power.
· Consider adding a co-borrower – Is your spouse working but not on your current mortgage? Adding him/her could give you the income needed. You can also add a non-occupying co-borrower (such as a parent).
Tips – Down Payment
· Consider an FHA loan – FHA loans require the lowest down payments (3.5%). Conventional loans will go as low as 5% (3% for first time homebuyers), but also have stricter DTI requirements. Most zero-down mortgage options are reserved for first-time homebuyers, so that likely won’t be an option.
· Purchase from a family member – If you’ve been considering purchasing from a family member, the down payment can often be gifted equity. This has to be done appropriately, but is often an option when property is passed between family members.
· Consider gift funds or 401k loans – Gift funds, as long as they are documented and sourced, can be used for down payments as long as they come from appropriate sources (like family members, friends, or even employers). You can borrower against your 401k as well (the interest is just paid to yourself), but that payment will then need to be factored in and you’ll need to make sure you understand all of the ramifications.
Option 2 – Sell your current home, then buy your next home
If you have a place to stay in the meantime, this simplifies the process substantially. Hopefully, you netted some cash from the sale of your previous home, which can be used for/towards the down payments. You also no longer have a mortgage payment, so your debt-to-income ratios will be much less burdened. If you have family close by and can move in on a short-term basis or can find a place to rent on a short lease, then selling first might be a good option.
But, if you don’t have a place to stay and you don’t have the income or down payment to support 2 mortgages at once, then it becomes a question of careful- and fortuitous- timing.
You can apply for a new mortgage and indicate that you will have sold your current home before you close on the new home. The underwriters will then not include your current mortgage payment with your debt payments and you can get a conditional approval. That means that as long as your current home sells before you close on the new loan, you’re approved. The same can be done with funds for a down payment: you can indicate that the down payment funds will come from the equity from the sale of your current home and as long as the sale occurs and you have the required funds before the loan closes, you can still get that conditional approval.
As I mentioned, this requires timing to work out just right. The closing of the sale of your current home has to align with the closing of the purchase of your new home. This is called a “simultaneous close,” which occurs when you close on the sale of your former home and the purchase of your new home at around the same time (it can also mean closing a first and second mortgage at once). Since there are often delays and several parties involved, this can prove to be quite the feat.
Tips – Making a simultaneous close doable (without being homeless)
· Give yourself time on the purchase - Consider giving yourself a lengthy window on closing the purchase on your new home. The seller might want more earnest money in exchange.
· Thoroughly vet the buyers of your new home – Before you go under contract, require an extensive prequalification of the buyer so that there are no (or fewer) surprises.
· Rent your former home…to yourself – If the buyers of your home are flexible, you could arrange to rent the home from them for a few weeks while you close on your new home.
· Price your home aggressively – If you can come down on the price of your home, then you can be more picky as to who you sell it to. A buyer that can pay with cash poses far less potential problems than one that pays with a mortgage.
Option 3 – Rent your current home
Living in a home for a few years and then turning it into a rental is a great way to build retirement income (especially when you repeat the process several times). Just be aware of the following-
· Make sure you want to be a landlord – It’s not a bad gig, but it’s not for everyone. Talk to landlord friends (if you have any) to see what’s involved. We’re planning a landlord blog post shortly.
· You’ll need to qualify with 2 mortgages at once – Since you’ll be owning 2 homes at once, you have to qualify with both payments. If this is your first rental, you most likely won’t be able to count the rental income towards your qualifying income! The rules/amounts on that vary, but underwriters usually want 2 years of rental history before you can count rent from a new rental.
· Make sure your home is marketable – Is there a rental market for your type of home? In theory, you can rent anything, but higher-end homes often take a bit longer to rent.
In short, the best thing to do if you already own a home and are considering purchasing another is to consult with an experienced loan officer, preferably 6 months before you plan on purchasing. At Evergreen, we have substantial experience with upgrade home purchases and in almost any instance we can make it work!
