'Movin' on up' is hard to do
In a perfect world, you would sell your current home and buy your new home on the same day, moving seamlessly from one mortgage to the next. While this seamless transition has worked out for some repeat homebuyers, others have managed to sell their homes and rent them back until they find a new home to buy.
But if neither of these timing options works for you, you'll need to secure a financing option that lets you buy your next home before you've sold your existing home.
Here are five financing avenues to explore that may help you in the move-up homebuyer process.
No. 1: Bridge loan or wrap financing. "Bridge loans have not quite gone the way of the dodo, but they are extremely rare," says Scott Davis, branch manager of Homestead Funding Corp. in Fairfax, Va.
Jon Bass, executive vice president and director of marketing and advertising for BB&T in Greensboro, N.C., says that homeowners need substantial home equity, excellent credit and income to qualify for a bridge loan.
Bass says a bridge loan, which wraps your payments for your current home and your next home into one loan, typically lasts for six months up to a maximum of 12 months. Rates for these interest-only loans currently range between 6.5 and 8.0 percent, with a maximum debt-to-income ratio for a bridge loan is 40 percent, says Bass.
However, Bass says BB&T calculates your debt-to-income ratio based on a payment of 1 percent of the loan amount just in case it takes longer to transition to a permanent loan. For example, if the combined value of both your current home and your new home is $300,000, your ratio would be calculated based on a payment of $3,000, even though the monthly payment on a 6.5 percent interest-only loan would only be $1,625.
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"Your bridge loan can only be up to 80 percent of the combined value of both the homes you're using as collateral," says Bass.
Borrowers must pay bridge loan closing costs, including a loan origination fee of 0.5 percent to 1 percent, and then pay closing costs for the mortgage on their next home.
No. 2: Home equity line of credit or cash-out refinance. Tim Ross, president and CEO of Ross Mortgage Corp. in Royal Oak, Mich., says that a home equity line of credit can only be approved for a home that's not on the market. He says most lenders offer home equity lines of credit up to 80 percent of your home value.
"If you wanted to use a home equity line of credit for a down payment on your next home, you would have to qualify for all three loan payments: your current loan, your home equity loan and your next mortgage," says Ross.
Michael Jablonski, executive vice president and retail production manager for BB&T Mortgage in Wilson, N.C., says a cash-out refinance is also an option, but he doesn't recommend it because the upfront closing costs and fees are very expensive.
"You always have to realize that borrowing money will impact your next transaction," says Jablonski. "You'll have to qualify for your next mortgage as well as the payments on the cash-out refinance."
No. 3: Borrow from relatives. If you have relatives willing to provide you with cash to make the transition from one home to another, that can be a good solution to your move-up dilemma as long as they are also willing to provide the appropriate paperwork.
"You have to paper-trail everything now for a loan, so you would have to show where the money comes from," says Davis. If the money is a loan, you'd have to document a payment plan as part of your debt-to-income ratio.
Ross says you can use gift funds for your entire FHA down payment but your relations would need to be providing the funds as a gift rather than a loan.
The rules for down payment gifts on a conventional loan are slightly more complicated. If your down payment is 20 percent or less, only 5 percent can come from gift funds, but if your down payment is above 20 percent, the entire amount can be a gift.
No. 4: Borrow from your 401(k). "If your company allows it, it may be worth exploring the option of borrowing from your 401(k) because you can repay yourself when you sell your home," says Jablonski. "Make sure you know your employer's rules and that you are not incurring any IRS penalties."
Most 401(k) plans allow you to borrow up to $50,000 or 50 percent of your vested balance, whichever is smaller.
No. 5: Take out a personal loan. Davis says homeowners without enough equity or enough available funds in a 401(k) may qualify for an unsecured personal loan. However, he says the interest rate on these loans is typically around 15 percent and usually last for just a few years. In addition, the borrower would have to include payments on that loan when qualifying for a mortgage on their next home.
For homebuyers moving up from one home to the next, it's either going to take enough income and assets to qualify for two mortgages, the ability rent back your former home while you shop around, or a helping hand from a family member.
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Michele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time", has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT's REIT magazine and numerous Realtor associations.