Buying a new home is always an exciting milestone in a person’s life. Then, selling that home to upgrade to a new one is the typical next step in the journey. Unlike buying a home for the first time, however, trying to buy one home while selling the one you have can turn into a headache.
It doesn’t have to though. You can make your current home work for you instead of against you by using your home equity to purchase your new home.
Curious about how to use the equity you have in your current home to purchase a new one? Wondering why you’d want to and if it’s right for you? We have answers to these questions and others below.
What is a Home Equity Loan?
Home equity is the difference between your home’s value and the amount you still owe on it. In other words, it’s the money you’d have left over if you sold your home and paid off all loans against it.
For instance, if you purchase a home worth $200,000 with no down payment, you would have zero equity the day you moved in. However, if you put twenty percent of the purchase price down at closing, your loan amount would only be for $160,000, meaning you’d have roughly $40,000 in equity in your new home. Note that this doesn’t factor in the portion of your down payment that goes toward paying off closing costs, which will slightly reduce your home equity in the case above, but typically not by more than 2-3%.
You can also gain equity in your home if the market changes. If you purchase a home and the housing market takes a drastic upswing, you could earn quite a lot of equity in the process.
A home equity loan allows you to receive the equity you have invested in your home in the form of a cash out. You still own the home, but you take out another loan against your home that roughly equates to the majority of your equity. The loan is collateralized by your home equity so you typically get a competitive interest rate.
While many people use home equity loans to do renovations or consolidate debt, more and more people are turning to this form of financing when purchasing a new home.
Benefits of Using Home Equity to Purchase a New Home
Traditionally, you would list your old home at the same time you begin looking for a new one. If your house happens to sell quickly before you find a new home, you have your equity but are faced with finding an interim place to live. If you find your dream home but your old home hasn’t sold, you either have to rush to sell your existing home before your new home purchase closes, or you have to make an offer on the new home that includes a “home sale contingency,” which sellers typically don’t like.
However, with a home equity loan, you’ll get to tap into your existing home equity before selling your home. This gives most buyers the cash they need for the down payment on their next home. The process for getting a home equity loan from a bank begins with applying and getting approved. The loan will be a separate loan that you also need to make payments. Once your home sells, you use the proceeds of the sale to pay off your original loan and the home equity loan. Be aware that a home equity loan often has fees attached to it, but its benefits may be exactly what you need.
1. You don’t have to divert money from other assets to fund your new home purchase. In order to make up for the differences needed to purchase a new home while waiting for a current one to sell, many people choose to move money from savings and retirement accounts. Unfortunately, this often means fees and penalties are incurred to gain access to these accounts.
2. You can take contingencies out of your offer. A seller will always prioritize a non-contingent offer over one that contains contingencies. One of the most common contingencies is one that stipulates the buyer’s current home must sell before the new purchase can go through. This means the seller is waiting on their buyer’s home to sell before they can close their own sale.
While sellers will likely take an offer with a contingency as a failsafe, they may continue to look for other buyers. If one comes along that doesn’t have a contingency, you could be looking at losing out on your dream home to someone who doesn’t have to wait to buy.
3. Cash offers are more appealing to buyers. Some companies that provide home equity or bridge loans actually provide the means for you to use your home equity to make an all cash offer on a new home. With a cash offer on the table that has almost no contingencies, you’ll be ensuring your offer is attractive to the seller.
4. You could receive discounts for a cash offer. Further, a seller will sometimes consider a small discount for a cash offer, meaning you could save yourself money by using your current home equity as leverage to buy your new one.
5. There’s less waiting and hassles. Instead of trying to get all the logistics to work between selling one home and moving into another simultaneously, you can take it one step at a time. Find your dream home while you’re still living in your current one. Then make an offer and secure your new home before you even list your old one. Once you list your home, then you can deal with selling once the chaos of moving out is done.
One Big Downside of Using a Home Equity Loan
There’s one big downside of a home equity loan to purchase your next home: it can make it harder for you to qualify for a mortgage. You need to qualify for a mortgage loan to purchase your new home, and that requires not exceeding the lender’s debt-to-income, or DTI, ratio. The lender will typically calculate your monthly debt using your old mortgage payment, your new mortgage payment, and any required home equity loan payments you have to pay. So if you’re already close to the lender’s DTI limit, you may want to reconsider using a home equity loan.
The Homeward Way
Alternatively, there’s The Homeward Way where the first step to getting into your new home is to apply and get approved. Once approved and aware of your budget, you can begin shopping for your new home.
When you find your dream home, we’ll make an all-cash offer for it on your behalf, and secure it. You can then list your old house whenever you like. While it’s being marketed, you’ll rent your new home from us. After your home sells, you’ll close on your new mortgage loan and buy your new home back from us along with a 1.9% convenience fee for our service. If your old home doesn’t sell for any reason, we’ll buy it from you at a pre-agreed fair market price.
Get approved online with Homeward today to see how we can take the stress out of your home buying and selling process.
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