Home ownership is often a process. You buy your first, relatively modest home, build some equity, and then after a few years move up to a nicer, more expensive one. But how do you arrange financing to buy that new home when you're still making mortgage payments on the old one?
Upgrading to a new home used to be fairly easy. The equity and credit history you built over several years of owning your first home made you an attractive prospect for lenders who were willing to flexible financing to help ease you through the transition from one home, and mortgage, to another.
But in today's tight-credit marketplace, that's much harder to do. So how do you juggle the handoff between buying a new home while selling your old one?
You could always sell your present home, then rent a place to live while you're looking for a new one. However, many people would prefer a more seamless transition, not to mention avoiding the inconvenience of moving twice while putting some of your goods in storage. Here are a few other options to consider.
If you can swing it, a contingent offer is one of the most straightforward ways to make the transition from one home to another. The way it works is you make an offer to buy new home, contingent on selling your old one. Once you get a qualified offer to buy your old home, you close on the new one and pay off your old mortgage with the proceeds from that sale.
"Contingent offers are making a comeback," said Renee Wiginton, a real estate financial advisor in Anaheim, CA. "Up until about a year ago, you couldn't consider a contingent."
There are several requirements for buying a new home using a contingent offer, Wiginton said. First, your old home must be priced to sell - and you'll need a professional appraisal to prove to your lender that it is an attractive price.
Second, you don't have a lot of time. Typically, a lender will only allow a new home buyer 17 days, maybe a month, to accept a qualified offer on their old home and have it move into escrow, or the lender may rescind the loan offer.
Whether you can use a contingent offer or not will depend in part on the area you're buying in, and the market conditions there. Joe Spisak, sales manager for Inlanta Mortgage in Oak Brook, Ill., says he's still not seeing many contingent offers go through. He said that's because in a seller's market like the Chicago area is experiencing, sellers are more likely to have competing offers with fewer strings attached.
"They're going to go for the path of least resistance," he said.
Home equity loan
Another option, if you have significant equity built up in your old home, is to apply for a home equity loan to use in funding part of the purchase of the new one. Then when you sell the old home, you can pay off both the home equity loan and the old mortgage as well.
"The challenge with that is they would have to qualify both homes," Wiginton said. That is, the borrower must be able to show they have enough income to handle the monthly payments for the home loans on both houses at once.
Since lenders typically don't want to see borrowers spending more than 40 percent of their monthly income on debt of all kinds, that can be a tough standard to meet.
In addition, when applying for the home equity loan you have to be upfront with the lender and let them know you plan to vacate the property and buy a new home. That will raise the cost of the home equity loan, but to fail to disclose such plans would constitute fraud, Wiginton said.
Tapping a 401k
Another popular option is to borrow down payment money from a 401k retirement plan, then repay the account once you sell. This is allowed without penalty under federal law, although the rules vary among individual 401k plans. Check the "terms and conditions for withdrawals" on your 401k to see what's allowed on your plan and if there are any additional costs involved.
Just like with using a home equity loan, you'll still have to get qualified to carry both your old and new mortgages simultaneous. Depending on how much you can temporarily draw out of your 401k, though, you may be able to whittle down the size of the mortgage on your new home enough so that it's not that high of an obstacle to meet.
Rent it out
If you can't use a contingent offer, and you can't qualify for carrying two mortgages at once, you might consider turning your old home into an income property by renting it out. That way, your lender will count the rent you're receiving as income to help you qualify to carry both mortgages.
To do this, however, you need to have a renter lined up and a lease signed before you close on the new home, Spisak said. You can't simply tell your lender that you're planning to rent the property and expect them to qualify you on that basis.
However, your renter doesn't actually have to be moved in to your old home in order for you to count the rent as income toward qualifying for the new loan. As long as a lease is signed, Spisak said, you could apply for your new mortgage in June, close on July 1 and subsequently move out and have the renter move in.
The FHA option
Wiginton suggested that another possibility is to buy the second home with an FHA mortgage, then refinance it into a less-expensive Fannie Mae- or Freddie Mac-backed loan after the old home is sold. In fact, she helped a borrower with such an arrangement just last week.
The fees on FHA mortgages have risen quite a bit the past few years, but you can still get one with only 3.5 percent down. They also have looser credit score requirements than conforming Fannie/Freddie loans. So that makes them a possibility for someone who can qualify the carry the payments of two mortgages, but either cannot or is unwilling to put up a large down payment.
Down payment assistance
A final option for certain types of buyers is to look to federal or state programs that offer down payment assistance. Although these are usually aimed at first-time buyers, Spisak said some of them are also available to repeat buyes in certain income brackets who are looking to buy a different home in a qualifying area.
The availability of such assistance and rules vary from state to state. In Illinois, it's available through the Illinois Housing Development Authority (IHDA), though Spisak said there are similar programs in Wisconsin and Massachusetts, among others.
"A lot of states have these programs," he said.
One to forget - for now
Bridge loans, a type of short-term financing that extended credit for buying your new home on the expectation you'd soon be selling your old one, were quite common before the crash. They were also a fairly costly type of credit. But these days, they're pretty much extinct.
"There isn't a viable bridge loan product available right now," Wiginton said.
However, both Wiginton and Spisak said they expect bridge loans will eventually make a comeback, as the market changes and lenders once again feel confident making such loans. But for now, they're pretty much off the shelf for residential mortgages.