By Howard J. Willis *
In earlier articles our readers have been briefed on the state of the Weston, Davie, and Southwest Ranches home market. Characterized by decreasing inventory and rising prices, these conditions impact potential buyers and sellers in a number of ways. Successful buyers must be nimble in bidding and negotiating on the home of their dreams. Smart sellers want to select their best offer and be assured of their sale going through without delays or worse a surprise cancellation. By considering one way a buyer can purchase that dream home now before the sale of the current home, perhaps both buyers and sellers can be better prepared in this dynamic home market.
“How Do we Buy This Home When we Need to Sell the One we Own Now?”
We find this question more and more as buyers compete for at times only a handful of homes that meet their criteria. Sellers can afford to be more discriminating in their selection of offers and typically object to the following conditions that historically have been almost givens in buying a home:
1) Contingency on the Sale of the Buyer’s Current Home: Sellers will avoid accepting this assuming all else is equal among the offers. So it becomes critical for the buyer to seek alternatives until he or she can sell the existing home after buying the new home. But most buyers are reluctant to negotiate a new home purchase and put down significant dollars without the certainty of at least a binding contract on their current home.
2) 90% to 100% Mortgage Financing: Despite the fact that buyers have a variety of motives for this type of higher leveraged financing, the fact remains that many sellers see higher leveraged deals as a risk. The seller has the impression (sometimes justified) that the buyer may not be as financially strong as he/she needs to be for the lender. But most buyers are either reluctant to write a check for a significant deposit or unable to produce the cash to put down on their new home without selling their current home and obtaining the equity in their homes to re-invest. In conversations with a number of mortgage bankers, they indicate that really the savvy home buyer today is indeed looking to put less down than we have seen in the past.
A Credit Solution to the Buy/Sell Dilemma
We are seeing with greater frequency the use of the home equity loan on the buyer’s new home rather than the existing property. While the idea is not that innovative, it is novel in its application as a second-mortgage on the new home. Why would a buyer pursue this option? The buyer can leverage or borrow on the value of the new home’s equity (Appraisal less first mortgage amount & costs = move-in equity) in order to have the cash needed to purchase the home without first selling the current home. The second mortgage can be an interest-only loan that will require a minimum of a payment burden until the buyer can sell the first home. This approach provides the buyer a cushion of cash by using the equity in the new home and taking the pressure off by having to sell the current home prematurely. Remember that this 2nd mortgage may be set up as an equity “line” if one prefers.
This short “window of time” is the enemy of maximizing the home’s sale price. By not having the shadow of the new home’s closing looming in the short term one can properly market and maximize the yield on the current home’s sale. By having the cash to close on the mortgage one prefers to have, one has the security of knowing he or she has done the right thing on the long term costs of the first mortgage. If the buyer has priced and prepared the home properly, the existing home should sell within (30) to (60) days. Should the sale be delayed, there would be additional interest-only payments on the second mortgage, continuing payments on the current first mortgage and carrying costs for each property. Be sure to avoid if possible a pre-payment penalty on the 2nd mortgage.
Let’s look at the numbers and the flow of events:
ECONOMICS
SOURCE USE
New Home OF FUNDS OF FUNDS Notes
Market Value/Sale $625,000 Appraisal
First Mortgage Primary Lender 500,000 80% LTV
Second Mortgage 125,000 20% LTV
3% Deposit/Contract to Buy (funded by buyer) 18,750 At Contract
1st Mortg Down Balance (funded by 2nd) 106,250 At Closing
Closing Costs – Both Mortg (funded by 2nd) 17,625 Estimated
Interest-Only Monthly (funded by buyer) 2,500 Budget (3) Months
Balance of 2nd 1,125 Balance left
Buyer’s Out of Pocket Cash Before Closing $21,250
Present Home
Market Value/Sale 495,000
Pay-Off First Mortgage 297,000
Closing Costs 37,126 7.5% estimate
Pay-Off 2nd Mortgage 125,000 Proceeds from Sale
Mortgage Payments (funded by buyer) 5,500 Budget (3) months
Other Carrying Costs (funded by buyer) 1,800 Until Closing
Balance to Buyer/Sale Proceeds at Closing $35,874
|
CALENDAR
WEEK ACTIVITY
1 Buyer … Selects Realtor/Decides Criteria
2 Pre-Qualifies 1st & 2nd Mortgage
3 Continues Home search / Lists Home
4 Finds Home/Makes Offer/Enters Contract
5 Negotiates 1st & 2nd Mortgage Loans
6-10 Period to Sell/Contract to Sell Own Home
7-11 Closing on New Home
10-14 Closing on Sale of Own Home |
An Interesting Result
While this example includes a number of assumptions, having adequate equity in the new home is a key factor. The buyer in this scenario started the mortgage application process even before knowing what home would be purchased. Try to obtain a firm commitment at this time rather than settling for a pre-qualification letter. The buyer will need to locate the source of funds for the initial deposit at signing the new home sales contract. In our example the buyer must fund the 5% and continue making mortgage payments and carrying costs of both homes. Thanks to Uncle Sam the net costs of these payments are minimal since most homeowners benefit from the homeowner tax credit. The buyer’s balance of funds for his or her personal account is significant and the buyer was in a strong position to close on the home of their first choice.
Not For Everyone
Buyers may have the opportunity to use the higher levels of market demand to their own benefit. In this case it is assumed that the buyer’s home is likewise in a healthy market where the average Days on Market (DOM) are less than sixty days or so. If the home is priced correctly and shows well, the risk of extending the second mortgage beyond ninety days should be minimal. The buyer should weigh this scenario carefully as it does require funding two mortgages and the carrying costs for both homes after the closing of the new home and before the closing of the current home. One attractive element of the interest-only second home equity line is that there is a cushion in the event the current home’s sale takes longer than planned.
The family income and credit worthiness of the buyer is important too. A credit score in the 660 and above range is usually required by the primary and secondary lenders in order to qualify and obtain a pre-approval fairly quickly. The buyer should also review with the mortgage banker how their current income and credit ratio stack up when considering this solution. While the potential contingency in the example should be more than enough for most people, the buyer is advised to be sure there is adequate and liquid assets to support any un-budgeted costs.
First Steps
If you are a potential buyer who finds this solution attractive, a series of first steps are called for to get the process rolling. Identify and select your Realtor and your mortgage banker. Sit down with these professionals and explain what you are trying to accomplish. Tell them that when you find the home of your dreams that you want to be the most attractive buyer with a strong offer who is ready, willing and able to act. Your banker will help you arrange the second mortgage/equity loan usually from another community-based bank. Be sure to compare the differences between securing a home equity line on your current home and a second mortgage on the new home. You will need to be prepared to tell the second mortgage banker how much you will want to borrow. Your Realtor can assist you in estimating the estimated listing and selling price of your current home. From this exercise you will know approximately how much you will have left over in cash proceeds. You can decide from this amount how much money you would like to invest in the new home. Ask your banker to prepare a similar chart like the one included here so you can clearly understand where and when the money is coming from (the sources of funds) and where the money is going (the uses of funds). Hopefully, this has proved useful to you and your family as you or someone you know navigate the buyer’s often choppy waters of locating and buying your Florida dream home.
*Howard Willis is a realtor with Esslinger-Wooten-Maxwell Realtors and a principal of the Allegra & Howard Willis Real Estate Group. Howard has a law degree and specializes in providing real estate sales and services to premium home and condominium owners. Call with your questions and comments to (954) 949-0444 or to @thewillisgroup.com. Learn more about Allegra and Howard at www.thewillisgroup.com
