Here are tips to buy that home without wrecking your finances
By Patricia Sklar and Bud Boland
Have you found yourself daydreaming about, or even looking for, that next new home? With interest rates at historically low rates and people stuck at home with the enhanced ability to work remotely, many people find themselves actively hunting for that next place to call home.
Home sales have been steadily increasing in recent months, with sales of existing homes jumping nearly 21% in June compared with May, according to the National Association of Realtors.
This means inventories are low in much of the country, so you may need to move quickly. And you may not have time to sell or even list your current home before making that offer, especially if you have children. If you have a lot of equity in your current home, there are several options.
Here are some solutions to consider:
Use your savings: According to the NAR, 60% of buyers secured a down payment from savings. If you don’t have the cash, then selling stocks and bonds in an investment account is often an option to consider in order to qualify for your new mortgage.
The downside is that you will likely incur capital gains taxes on any investments that have increased in value since you purchased them. Moreover, this removes those investments from your account that could otherwise be working for you, and you might miss out on a good run-up in the market.
Borrow money against investment accounts: Instead of selling investments to raise cash, it might make sense to borrow money using these same investments as collateral for the loan. This can be done either via a margin loan from the brokerage firm that holds your investments, or from a bank that offers a pledged asset line of credit.
These options allow you to borrow cash against the value of your investments and pay back the loan when your first home sells. Be mindful of the interest rate that you pay on these loans.
Also, keep in mind that since your collateral is investments which fluctuate, a significant decrease in the value of your investments may trigger a “margin call” if your collateral is no longer sufficient. In this case, the lender may require you to put up more collateral or sell investment assets being used as collateral to pay down the loan balance. This would likely mean selling investments at an inopportune time when values are down.
We often help our clients evaluate which option makes sense. Typically, a margin loan or pledging assets makes a lot of sense for our clients if they plan to pay off the loan in a short amount of time. However, we have seen situations where it made more sense to sell securities, such as when a client was in a low tax bracket.
Get bridge financing: According to the NAR, 38% of buyers used the proceeds from selling a home for a down payment. One way to use those proceeds prior to selling is bridge financing. It is similar to getting a home equity line on your current home. The difference is that you can get this line of equity on a home that was listed recently, as banks tend not to lend for six months on a home that has been listed.
Be careful with the terms of these loans. You want one that allows you to keep your great rate on your first mortgage until you sell your home. This is different from a bridge loan that pays off your current mortgage and replaces it at a higher rate, usually with a balloon payment. Also, check closing costs, as they may make it an undesirable option.
Consider a sale-leaseback arrangement: If all other options are off the table, a sale-leaseback arrangement might be an option. This strategy assumes you sell your home before buying. A sale leaseback allows a seller to remain in the house by renting it back from the buyer after closing.
Details of the arrangement such as monthly rent, who pays various utilities and expenses, etc., must all be negotiated in advance and often lenders won’t allow the leaseback period to exceed 60 days. This is a fairly common strategy for those who need to sell but have not found their next home yet.
On the other side of the transaction, this can also help a buyer’s bid stand out from others in a crowded market where multiple bids are being submitted.
Don’t dip into those retirement accounts: It isn’t typically ideal to derail your retirement to buy a new home. However, it can be especially tempting if you qualify for a loan or distribution under the CARES Act. If you are dead set on using your 401(k) plan or individual retirement account, then check to see what rules your situation qualifies under and make sure you follow them.
Recast your loan: Last, if qualifying for a new mortgage on top of your existing mortgage is not an issue, but you simply won’t be able to put as much down as you would like (i.e., you have to get a bigger mortgage than you want), you may have an option once the dust settles: a mortgage recast.
After receiving the cash proceeds from selling your home, you may be able to make a significant one-time payment of principal towards your new mortgage and ask the lender to recast your loan. This process will recalculate your monthly payment based on the new mortgage balance effectively reducing your monthly payment and the amount of interest you will pay over the life of the loan.
A recast does not change the interest rate or other terms of your loan. Many lenders offer a recast feature upon request provided you are willing to pay a nominal fee.
It’s key not to overextend yourself. Ever heard of the term, “house poor?” You don’t want to find yourself short on cash and struggling to make multiple payments at once if you can’t sell your current home for a while.
Make sure you set aside enough cash in case you have to carry two mortgages for a while or make repairs to the current home. You don’t want to become a forced seller, as that can put you in a tight spot.
It is important to plan ahead and decide how financing will work with your situation. You don’t want to let that perfect new home go to some other buyer who was more prepared with their offer than you.
Patricia Sklar and Bud Boland are wealth advisors at Brightworth.