Your client is interested in moving. They need to sell their old house first before buying a new one, right? After all, they don’t have enough of a down payment for the new house without selling the old one, and they are pretty certain their bank will not qualify them for two mortgages.
The homeowners are in a dilemma: Houses in their area are currently receiving multiple offers. Inventory is low. Sure, they can sell their house under the same circumstances, but will they find a new house so they can simultaneously move from the old house to the new one? Unlikely. Do they sell the current house, move to a rental [or hotel] while they identify and close on the new house? Is the extra hassle of moving twice and the added stress worth it? Is it worth the added costs of securing a second mortgage until you sell the old house? How much is peace of mind worth?
These questions are a reality in many parts of the country, specifically in the San Francisco Bay Area, because of the real estate rebound after the Great Recession. According to Jeff Stricker, a real estate professional with Alain Pinel Realtors specializing in the Silicon Valley in California, many clients are faced with these exact situations, as property is swooped up soon after it hits the market, and often with multiple offers over the asking prices. Strickler states that, although it is great for his clients as sellers, those same clients face challenging hurdles when buying a replacement property. They compete against other buyers, some with cash-only offers, who are willing to bid far beyond the asking price. Some buyers are so frustrated with the process of competing and getting outbid that they act in ways they normally would not: Overbidding, settling for a less-than-ideal house, and the list goes on.
Strickler, however, decided to think outside the box. What would happen if the buyer purchased another house prior to the sale of the old house? Is it possible given the recent banking regulations that developed due to the mortgage meltdown in 2008? Due to Dodd Frank rules that placed inordinate restrictions on the homeowner’s ability to obtain financing, many people are unable to get loans for which they previously qualified.
Strickler came up with a spreadsheet in which, if he plugged in some assumptions, he could figure out if it would make economic sense to acquire a new house before selling an old house. The other part of the equation was to find a lender who would allow for a homeowner to purchase a new home without first selling the old home, thus carrying two mortgages at the same time. Since most conventional lenders would not touch this, Strickler looked to alternative sources. He found a company called Pacific Private Money, in Novato, Calif. that specializes in such a product.
Pacific Private Money can lend enough to the borrower to purchase the new home if there is enough equity in the old home to justify a combined Loan to Value [LTV] of 70% or less. Sometimes, if there is not enough equity in the old home, the borrower needs to add cash to bring the LTV to 70%. This can solve many issues for the homeowner. First, the new home can be identified without adding pressure since the homeowner is still living in the old house until the new house closes escrow. Second, the stress of moving twice is eliminated. Third, and probably the best [and possibly most surprising] is that this solution may actually cost less in terms of increasing net equity when the new house is more expensive house than the old house.
In a rising market, the earlier the purchase of the more expensive new house and the delay of the sale of the old will increase the net equity to the homeowner more than the costs associated with carrying two mortgages.
For example, let’s assume the old house is worth $1 million and there is currently a first mortgage of $200,000. The homeowner desires to purchase a new home for $1.4 million and has $100,000 in the bank for a down payment. We will look at two scenarios: The first is where the homeowner sells the current house, rents for a period of time, and then purchases a new home; the second scenario is where the homeowner borrows the money to secure the new home while owning the old home.
Obviously, there are many moving targets with both scenarios, such as how much it will cost to rent a place [in the event of selling the old house first] as well as time needed to identify and close on the new house, storage costs for belongings, the cost of obtaining a private loan, and the appreciation assumptions for both houses.
The following calculation(see graphic) makes the following assumptions:
• It takes nine months to close on a new house after selling the old house,
• Houses in the area (both old and new) appreciate at 1% per month,
• Interest earned on bank deposits are 1% per annum ,
• Storage costs are $1,000 per month,
• Homeowner does not qualify for a conventional bank loan and must use a private loan company,
• The costs for the private loan are 9% plus 2 points, and
• The interest rate on the old house is 3% per annum.
As you can see, in a rising market where the new house is worth more than the old house, there is a significant benefit to using a private loan to purchase the new home and sell the old one at a later date. Waiting nine months to acquire the new house has tremendous opportunity costs compared purchasing the new house right away and eventually selling the old house.
Although assuming a 1% per month appreciation of real estate may seem aggressive, the San Francisco Bay Area, and specifically the Silicon Valley, has experienced such growth. However, even if we lower the appreciation to ½% per month, we still see a fairly significant benefit to purchasing the new house now rather than waiting to first sell the old house and then buy the new house.
Aside from the economic benefit, other factors need to be considered: the lack of stress of moving twice and the ability to purchase immediately. In today’s market, sellers are not willing to take contingent offers. Can the homeowner budget for both houses at the same time while waiting for the old house to sell? Is the market rising? How long will it take to sell the old house? These are just some of the issues to consider before deciding. However, no one wants to miss out on the right opportunity. The ability to purchase right away means they can start looking at new houses before selling the old. This also allows them time to make any repairs or otherwise maximize its value prior to placing it on the market.
Once homeowners know there is potential to purchase a new house before selling their old house, they can obtain a commitment letter from the lender. Of course, homeowners should see if they qualify for a conventional loan first, but they should keep their minds open to procuring a private loan should the bank turn them down.