The timing of buying a house when you already own one can be tricky, especially if you’re relying on the proceeds of your home sale to make your down payment. However, there are several reasons you might want to buy your next house before selling your current one.
For instance, buying first allows you to move directly into your new home instead of crashing in a rental while you wait for your closing date. Buying before you sell also gives you more time and flexibility to prepare your old house for the market.
If you want to buy before you sell your current home, you may be wondering how to come up with the cash for your down payment. Fortunately, there are several strategies that can help you navigate this timing dilemma.
Contingent Offer
One of the most popular ways to buy and sell a home at the same time is to include a home sale contingency in your offer. This contingency states that you must sell your current house for your new home purchase to be finalized. If you can’t sell your home by a specific date and for a specific minimum amount, you can walk away from the new home purchase without a penalty.
Pros:
The home sale contingency ensures you won’t get stuck with two mortgage payments.
You don’t need to apply for other forms of financing.
You avoid interest and fees from taking out another loan.
Cons:
A home sale contingency weakens your offer because it increases the likelihood the sale will fall through.
You’ll lose out on your home purchase if you can’t sell your house within the stated time frame.
You face the stress and pressure of trying to sell your home while also working toward closing on the new property.
Bridge Loan
A bridge loan is a form of financing that’s designed to cover a gap in time while the borrower secures longer-term financing. In real estate, bridge loans can be used to cover the down payment on a new house until the borrower receives the proceeds from their home sale.
Bridge loans usually have a repayment term of three to six months, but some lenders will extend them to a year. As long as you sell your house before your repayment is due, you can use the proceeds from the sale to pay the loan off in full.
Pros:
Bridge loans allow you to make a stronger offer by forgoing the home sale contingency.
Loan approval can happen within a matter of days, so it’s one of the fastest forms of financing.
Cons:
Bridge loans can be risky for lenders and therefore have high interest rates.
The loan doesn’t provide any protection if your home sale falls through, so you’ll still be responsible for the loan repayment and both mortgage payments even if you can’t sell your old house.
HELOC
A home equity line of credit, or a HELOC, is another common way to borrow money for a down payment when you already own a home. With a HELOC, you open a line of credit against the value of your house. When you sell your home, you can use the proceeds to pay off the debt.
Most lenders allow you to borrow up to 85% of your home’s value minus your mortgage balance. For instance, 85% of a home worth $500,000 is $425,000. If you owe $200,000 on the mortgage, you could borrow up to $225,000.
Pros:
Instead of taking out a lump sum, you can withdraw from the line of credit as needed.
HELOC funds can also be used for moving costs, home repairs, and other big expenses.
HELOCs have a lower interest rate than bridge loans.
Cons:
You need good credit to be approved for a HELOC.
HELOCs usually have variable interest rates, so your interest could go up over time.
Borrow From Retirement
If you have retirement savings, you could withdraw or borrow from the account to fund your next home purchase. If you have a Roth IRA, you can withdraw any amount you’ve contributed without fees.
Borrowing from your 401(k) is considered giving a loan to yourself, so you don’t have to pay income taxes or an early withdrawal penalty. You can borrow 50% of the vested account balance or $50,000, whichever is less. If you need to borrow more than this, you could take an early withdrawal from your 401(k). However, this withdrawal will be subject to taxes and penalties.
In most cases, 401(k) loans have quarterly payments with interest, but the interest goes back into your retirement account. These loans usually have a term of five years, but you can sometimes get a longer repayment term if you use the funds to buy a house.
Pros:
You can receive funds without undergoing a credit check.
401(k) loans can have flexible repayment terms.
Cons:
Pulling money out of your retirement account will interrupt your retirement savings goals.
You’ll face penalties if you miss a payment or fail to pay the loan back in time.
Rent Out Current Home
Instead of selling your house right after you buy a new one, you could rent it out. Although this won’t provide you with a lump sum for a down payment, it can be a good way to avoid paying two mortgages while you wait to sell your home.
Some homeowners rent their old homes out for a year or less while they get settled in their new place, and some rent out the property indefinitely. The rent payments can cover the mortgage, allowing you to continue building equity in the property.
Pros:
Rental income provides cash to cover the mortgage payment.
You can hold onto your old home while it rises in value, and you can wait for the right conditions to sell it.
Cons:
You still need to come up with funds for the down payment on your new property.
Depending on rental rates in your area, the rent payment may not fully cover the mortgage and expenses.
You face the responsibilities of a landlord, including the risk of a tenant not paying or damaging the home.
Choosing the Right Strategy
While there are a lot of benefits to buying your next house before you sell your current one, making a down payment and juggling two mortgages can feel daunting. To smooth out this timing issue, you could make a contingent, rent out your house for extra income, or take out a loan to cover your down payment and closing costs.
The right option for you depends on your unique circumstances and preferences. A HELOC can be a great option if you have strong credit, but a bridge loan is a good alternative if you’re confident your home will sell. If you have enough funds in your retirement, you could borrow against your 401(k) loan for a funding option with minimal fees and penalties. If you’re not comfortable closing on your new house until your old one has sold, including the home sale contingency in your offer is probably the best choice. Consult with your real estate agent and financial advisor to weigh all of your options and come up with a strategy that best fits your situation.