Homeowners on the move: How to fund your next down payment
For many young adults, buying, selling, and moving from a starter home to a new home is no small task. It can be even more complicated if you do not have enough cash savings tucked away to make a down payment on your new home before selling your current home. If you are in that predicament, let’s look at a few options to help you transition.
Home Sale Contingency Offer
Contingencies are protective clauses commonly used in real estate transactions for inspections and appraisals. But you can also use a home sale contingency, meaning you offer to buy the new home contingent upon selling your current home.
As a buyer, a contingency offer can be your cheapest route if everything works out. You can use the net proceeds from your home sale to fund the down payment on the new home. This avoids the need for additional loans or short-term financing. You also avoid the risk of multiple mortgage payments and additional interest if your home doesn’t sell quickly.
The downside is that your purchase offer becomes less attractive from the seller’s perspective. In addition, the home sale contingency adds risk for the seller since they have no control over your current home selling quickly (or at all!).
Especially in the current environment of low existing home inventory, homes are selling quickly, and sellers often have several offers to choose from. If the seller receives other offers without any strings attached, they will likely pass on yours. If your contingent offer is accepted, you’ll likely need to act quickly when selling your current home, especially if the agreement specifies a time period. The seller can back out if your home doesn’t sell within that period.
Short Term Financing
If you want to avoid the contingency offer and put your best foot forward as a buyer, then having short-term financing in place can help ensure you don’t miss out once your ideal next home becomes available. Here are several options:
- Bridge Loan. A bridge loan is paid as a lump sum using your existing home equity and is intended to be repaid upon selling your current home. It allows you to have cash ready for a down payment, thus avoiding a home sale contingency offer. However, this readiness comes with a price. You’ll pay closing costs on the bridge loan and it will have a higher interest rate than a typical 30-year fixed mortgage.
With 30-year fixed mortgage rates currently hovering around 7%, your bridge loan interest will likely be expensive. Also, be prepared to make monthly payments on the bridge loan in addition to your current mortgage payment.
- HELOC. A Home Equity Line of Credit (HELOC) is a revolving credit line that allows you to draw cash from the equity on your current home. HELOCs typically come with variable interest rates, but you can avoid closing costs when drawing from a HELOC. However, there may be early repayment penalties, so make sure you know the terms.
A HELOC can be a great low-cost option for the borrower, but the downside is availability. Banks typically won’t provide a new HELOC if they know your home is going to be sold in the near future. Instead, the bank would rather you use a bridge loan so they can collect closing costs. Therefore, the HELOC is likely only an option to fund your next down payment if you already have one in place.
- Retirement Plan Loans. Some retirement plans offer the availability of a short-term loan from your account balance. However, this option comes with extra risks and should be considered carefully. You will miss out on the potential growth of your retirement investments for the duration of the loan. Also, if you don’t repay the loan, including interest, according to the loan’s terms, any unpaid amounts become a plan distribution to you. That typically means taxes and penalties.
New Entrants: iBuyers
There are a variety of newer companies that aim to help homeowners facing this dilemma. Opendoor, for example, offers a convenient one-stop solution. They can make a cash offer to buy your current home (if your home qualifies), avoiding the hassle of the open market. You can also make an offer on an existing Opendoor home and schedule both closings simultaneously. Again, a very convenient model, but it typically comes at a cost, as you’ll likely need to accept a lower selling price on your current home than you would expect to receive on the open market.
As you can tell by now, each option has pros and cons. Take the time to fully understand these options before moving forward. It could save you an unwelcomed headache in the process.