Reverse the normal sell-then-buy process
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It’s a downsizer’s dream to be able to purchase that smaller home or condo before selling the current one. After all, who wouldn’t jump at the chance to move at your own pace, avoid a second move into temporary quarters with a houseful of furniture to store and sell your old home from the comfort of your new digs?
The problem is, most of us will need to tap the equity in our current home to make this downsizer’s dream come true.
Can it be done? Absolutely. There are a handful of financing and real estate options that can reverse the normal sell-then-buy scenario. But it takes timing, planning and some financial guidance to buck such an ingrained system.
Here are five strategies to master the downsizer’s waltz.
1. Get real on your home’s value
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The first step is to face up to your home’s current market value. If you think it’s worth more than the market will bear, it could linger on the market when it comes time to sell, putting you in a financial squeeze.
“It’s important to prepare to sell the house quickly because carrying the cost of two homes — including additional real estate taxes, maintenance and utilities — quickly eats up any potential exaggerated value you think you may have in your property,” says Bob Klosterman, a CFP professional and founder of White Oaks Wealth Advisors in Minneapolis and Longboat Key, Florida.
2. Calculate your down-payment gap
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The math is pretty simple. First, estimate the price range that meets your criteria for a new home; for example, $150,000 to $200,000. Next, calculate the 20 percent down payment you’ll need to avoid paying private mortgage insurance, or PMI, in the event you carry a mortgage. In this example, the down payment is $30,000 to $40,000.
Add closing costs to this estimate, as well, or about $2,500. So, if you have, for example, $10,000 in the bank, you’ll need to come up with an additional $22,500 to $32,500 to buy your new home, including closing costs.
“If (buyers) have the cash to do it themselves, it’s not a big deal,” says Jeff Gerber, an accredited buyer representative based in Phoenix. “But most people aren’t cash-flush enough to be able to pull it off.”
3. Apply for a home equity line of credit
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A decade ago, you could buy first with the help of an unsecured, short-term bridge loan. That’s unlikely today, however. A bridge loan helps bridge the gap between the sales price of a new home and the mortgage amount; it funds the down payment until you sell your current home.
“Those all but evaporated with the housing crisis of 2008,” says Klosterman.
Gerber agrees. “I haven’t seen anyone do that in ages,” he says.
Instead, one pre-emptive move to shore up your down payment and closing cost reserve is to take out a home equity line of credit, or HELOC. Can you use a HELOC in that manner?
“You can and you can’t,” says Jack Guttentag, professor emeritus of finance at the University of Pennsylvania’s Wharton School. “No HELOC lender is going to want to put a loan on a property that is going to be sold because it means that the HELOC life is going to go away and there will be no permanent customer relationship. It’s not an attractive transaction for them.”
The key is to obtain your HELOC before listing your current home. This allows you to tap up to 50 percent of your home’s equity to bring your new home within reach.
“Everybody says, ‘Why should I do that? I’m not going to need this money,'” says Klosterman. “The reason to have it is, it gives you the ability to act quickly when you see this unbelievable $600,000 condo listed for $400,000.”
4. No equity? Tap your portfolio
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Another way to shore up your buying reserve is to borrow against your investment portfolio or retirement account.
A security-backed line of credit, also called a margin loan, can give you short-term access to up to 50 percent of the value of your nonretirement portfolio. Klosterman recommends scaling that back a bit, however.
“From an investor’s standpoint, you don’t want to wind this too tight,” he says. “Borrow 40 cents on the dollar, and give yourself some room in case there is a temporary market decline.”
It’s also possible to borrow against your IRA or 401(k) retirement accounts. With an IRA, though, there can be steep penalties and tax consequences if you don’t replace what you borrowed within the 60-day limit.
Gerber says one of his clients tapped his 401(k) to buy new property before selling his existing one. “But that generally takes a good financial planner or stockbroker to help provide the guidance for that kind of decision,” he says.
If all else fails, there may be one avenue left.
“It’s possible that the lender on your new home would consider offering an unsecured bridge loan on your existing home,” says Guttentag. “There are a lot of disadvantages to this, including that you’re not going to get the best mortgage on your new house for obvious reasons: It’s unsecured. It’s not going to be very competitive.”
5. Negotiate a fallback plan
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If you’ve exhausted all options and can’t raise the cash to buy before you sell, you may still be able to buy yourself time to house hunt and possibly avoid an interim move by making your old home’s sale conditional on a 45- or 60-day close of escrow on your new home.
“Because home inventory is low right now, the seller does have a little bit of negotiating power on this point,” says Gerber. “That would give them a 45- or 60-day window to get their next property lined up and ready to close.”
If that doesn’t fly, another possibility, while a long shot, might work with the right buyer.
“You might try to do a rent-back. I’ve done that with a number of sellers who’ve agreed to sell on the condition they can rent it back for 60 or 90 days,” says Gerber.
Unfortunately, the housing collapse threw a wrench into that tactic — not for the seller, but for the buyer.
“Back then, lenders were a little more lenient with buyers,” he admits. “If you’re buying the home today, you’re generally signing a mortgage note that says it’s for your personal residency; it’s not income property. Because if you’re buying it as an investment in a rental property, that’s going to change the terms of the mortgage; they’re going to charge you more for it.”
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