Instead of modifying the words to the 60s classic, “Breaking Up is Hard to Do,” I could have used the words from a classic 70s TV theme song – Movin’ on Up. (“…Movin on up to the East Side, A Deluxe Apartment in the Sky…” Many of you know the name of the show and the rest of the lyrics. For those that don’t click Here for the link that will bring you up to speed. But I am warning you, this is one of those songs that could get stuck in your head all day. )
It may have been easier to move up to the East Side in the 70s than it is to move up in Vienna VA in 2012. It can be done but in this lending environment, it becomes more challenging then it was just a few years back. However, in any market environment, the same question exists – sell first or buy first? Let’s explore the pros and cons of each.
Buy First/Sell Second
To do this one must be able to a) carry two mortgages at once and b) have enough cash to put down on the new home without selling the old home. Many people may think they they don’t have the resources to go this route but there are ways to work it out. If one can make it work, I believe it is the better way to go.
Buying a home is a huge undertaking both emotionally and financially. Many people moving into a move up home plan to stay there for a longer period of time than the 1st home. Making the right decision is critical and buying first allows one to take as much time as needed to find the right home.
Of course, the down side is the possibility of having a double mortgage and being responsible for maintaining 2 homes for an undetermined period of time. Executed properly, we can minimize the overlap but it is still an unknown.
In our current Northern Virginia market, with inventory extremely low, this option has less risk than in a strong buyer’s market. Closely analyze the time it takes to sell a home in your neighborhood, double that time for safety reasons and if you can cover it, this may be a good strategy. However, you also must know your psychological make-up. I have seen people make poor contract decisions on their existing home when using this strategy. Sometimes, they take less for the house than they wanted because they are worried about carrying costs.
Overcoming the Income Issue
So what if one does not have the income to cover two payments? There are a couple of options here.
If one is close to being able to carry two mortgages but the issue is other outstanding debt, it may be worthwhile to restructure or retire that debt. For instance, if there is a relatively high car payment yet the remaining balance is low, it may be wise to pay off the car even if it means putting down a little less on the new home. Removing a $500 car payment can allow one to get another $100,000 in mortgage.
If the down payment was going to be on the low side and it was determined that an FHA loan was the best way to go, FHA rules allow a non-occupying relative to be a co-signer so one could use their income to get over the hump. For many obvious reasons, this may not be the best way to go but I have seen cases where families are about to expand and there is no way the current home will work so the homeowners have received help from family members.
Overcoming the Down Payment Issue
The lack of cash is a little easier to work with.
If there is equity in the current home and one has an untapped home equity line , that money could be used for the down payment. If there is no existing home equity line, check with your bank about opening one. For reasons too complicated to go into here, it may be difficult to open one once you are deep into the home purchase process but doing so before should not be a problem. Check with your bank for their guidelines.
I have seen buyers get loans from their 401Ks or IRAs to get over this hump. This is a little riskier as there are payback requirements on 401Ks (but interestingly, many lenders do not count that in your debt ratio) and if an IRA withdraw is not paid back within a certain time frame, there are tax consequences. Certainly check with your 401K or IRA administrator and a tax professional to determine if this makes sense for you.
And last, there are gifts. Under FHA rules, all of the downpayment and closing costs can be a gift from a blood relative. Conventional loans require a percentage of your own funds in the transaction and limit the amount of the gift if the buyer’s own funds are less than 20% down. But if the buyer is using 20% of their funds for a downpayment, the gifts from a relative are unlimited.
Sell First/Buy Second
For those who are very conservative, this option allows a good night of sleep. The current home is sold and there are no worries leaking pipes in the old, vacant home or leaking funds from the bank account for that old mortgage. Plus, you can qualify for more home without the mortgage from the old home on your credit report.
However, the logistics here can be problematic. This strategy works best for those buyers who a) have a place to hang out for an extended period – relative or friends house or b) are willing to rent for a short period and c) are not looking for a very “specific” type of home but have a more open ended home search.
Why do I say this? Let walk through this process.
Say, you get the perfect contract on your existing home – maybe even have a bidding war and get more than you expected – but that buyer needs occupancy in 30 days. It is very unlikely you will find a suitable home in that time. Even if you do, can that seller allow you occupancy that quickly and can your lender process that quickly? You need to have a temporary housing option available.
Unless the buyer is relocating from out of town with a family arriving in a few weeks or some other deadline situation, it is unlikely a buyer would demand such a quick close. For move up sellers, it is ideal if the buyer of their home has some flexibility on occupancy. If so, my favorite way to work this out is to use the “seller continued occupancy addendum.” In essence what happens is that the current home settles in 60 days and the seller has their money in hand. Then they have the right to stay in the home up to 60 days after settlement and pay “rent” to the new owners equal to the new owner’s mortgage payment or some other agreed to number.
So, once the contract on the current home is ratified, the sellers start to look for a new home. If they find one that can settle the same day as the old home, fantastic. If enough notice can be given, the rent back is not needed. But if more time is needed, it is available and the seller avoids a double move. Now if the seller can not settle before the end of the rent back, a double move will be required. The buyer’s lender will only allow a 60 day rent back before they consider the new owner a landlord which has all kinds of negative implications for the new owner’s financing.
Not every buyer can work with sellers on a continued occupancy arrangement. It works best when the buyer is currently renting. If that buyer is also moving up, the deal may get too complicated for this strategy. And there have been times when, based on the personalities involved or the tone of the negotiations, a landlord/tenant style relationship is not advised.
Again, know yourself psychologically. Some buyers are looking for very specific features in a very specific location. When the current home goes under contract, that style of home may or may not be available. For those types of searches it is really best to buy first. If one needs a home that is hard to find, the time pressure can cause undesirable compromises to be made (unless temporary housing is available.)
Other buyers I work with have a very wide open home search and are searching for a type of home commonly available without many geographic restrictions. This strategy tends to work better for these folks.
So, no right or wrong answer here. Deciding whether to buy first or sell first is very situational. Financial parameters, psychological parameters and the dreams and goals one has for their future home all come into play.
Some of you may ask why not a contract contingent on the sale of the current home or a contract contingent on a home of choice for a seller? Yes, they are possibilities but in this market, they are not desirable for reasons I will save for another post. Many sellers and buyers will not work with these and it really limits one’s housing choices.
Thoughts or comments? If you have done a move up, how did it work out? Was it stressful? Would you do it in the same order again?