If you bought your home eight years ago or more, you’ve seen your equity drop (possibly into negative numbers), then recover. Recently, you may have seen a neighbor’s home sell for a surprisingly high price. You may wonder whether your own property’s value might have increased as well, giving you an opportunity to sell at a profit, to buy a newer, larger or nicer home.
You may be joining the ranks of the Move Up Buyer.
When you first bought your home, you probably made a down payment of 20% or less—possibly a lot less. You may not have known it at the time, but you were already positioning yourself to take advantage of a powerful financial tool: LEVERAGE.
If you are able to buy a $200,000 home for a cash down payment of $20,000 (10%) and a mortgage of $180,000 (90%), the value of your down payment (equity) will increase at a faster rate than the appreciation rate of the home itself.
Here’s what we mean: the day you get the keys to your $200,000 home with its $180,000 mortgage, you have $20,000 in equity. Now, let’s fast forward five years. Let’s say your property is now worth $250,000 (about 4.5% annual appreciation). Your loan balance has dropped to $160,000 because of the payments you have been making for five years—but your equity has grown from $20,000 to $90,000—a 35% increase each year. That’s the value of leverage.
You might be thinking that you should put this windfall equity to good use. Perhaps your starter home is feeling cramped. Maybe your home is showing its age and a newer one, with more up-to-date appliances and appointments, seems appealing.
Your success in moving up depends on making a good plan. Here are the steps you should take.
1. Get a good idea of your NET equity.
This means finding out how much a buyer is likely to pay for your home, then subtracting your existing loan balance and the real estate commissions you’ll pay to sell your home (NOTE: deciding to sell without a professional agent may not be the money saving approach it seems to be. Most people who buy directly from sellers expect to reap the no-commission “savings” themselves. Give very careful thought if you are considering this approach).
A Realtor® will be able to give you a very good idea of the price your home is likely to bring when you put it on the market. When you calculate your net equity—that’s the total cash you’ll have available from the sale—be sure to allow for contingencies, like money you may have to spend to make your home attractive to buyers.
Consider getting a termite inspection before putting your home on the market. If there is termite work needed, you’re far better off knowing about it now, rather than later, when you’re in contract with a buyer.
2. Decide how much of your anticipated cash proceeds you will use in your new purchase.
Do you want to retain some cash reserves? Do you want to use some of that money to pay off consumer debt, once and for all? Keep in mind that the “traditional 20% down payment” is a myth. While it’s true that you will pay mortgage insurance with a smaller down payment, you may decide that using part of your available cash for other purposes could be a good strategy.
3. Contact a loan officer to help flesh out your plan.
Specifically, establish a budget for how much of the cash from your old property you will invest in the new home, and decide what total mortgage payment fits your budget. At that time, your loan officer will be able to look at your finances and tell you how much home you qualify to buy.
4. Now that you have decided on a realistic purchase price and terms, meet with your real estate agent.
Find out what properties meet the guidelines you have set. Can you find homes in your price range in areas you like? You may decide to give yourself some “wiggle room” when it comes to price, but your maximum will be based on the numbers you have discussed with your loan officer.
5. You should decide whether to sell your property before looking at other homes.
It is possible to make a “contingent” offer. This means that you tell a seller, “I’ll buy your home if I can sell mine.” Very few sellers are willing to consider offers like these.
If you wait to sell your home before looking for your new home, be aware that you could have the option of a “rent-back.” This means that you complete the sale of your old home, but enter into an agreement with the buyer to rent the home from them for some agreed period of time. This way, you’ll be able to close escrow on your new home without any complications or delays.
6. When you are ready to make an offer on a property, include a true pre-approval letter with your offer.
Pre-approval means that your mortgage company has reviewed your file carefully—credit, liquid cash, job and income verification—and is ready to approve your loan once you have identified the property you wish to buy. Sellers today are very reluctant to seriously consider any offer without a lender’s pre-approval.
Don’t skip any of these steps. Working in partnership with your loan officer and your Realtor®, you’ll be able to use your newfound equity to move up to what could be your dream home.