Everyone knows that now is an excellent time to move up: mortgage rates are at historic lows, and property values in most areas of the country are continuing to recover. But what if you find that your property hasn’t yet appreciated enough for a large down payment on your dream house? Are you out of luck?
The definitive answer, as with many other questions in life, is “That depends.” Assume for a moment that your home is likely to sell for a price that will pay off the existing mortgage balance and the agent’s commission, but only $10,000 in addition to that. There’s not much you can do with so little cash—or is there?
Low-Down Payment Options
There are many financing options available for cash-strapped buyers. FHA has been a low-down payment mainstay since 1934. Currently, FHA requires a down payment of just 3.5%—but there are some disadvantages. There is an up-front mortgage insurance premium of 1.75%, added to the loan balance and there is a monthly mortgage insurance premium (currently .85%) that will be in place for the life of the loan.
Disappearing Mortgage Insurance
Mortgage giant Fannie Mae now offers a 97% mortgage up to $417,000. Like its FHA counterpart, this loan also requires mortgage insurance, but there are two important differences: first, there is no up-front premium as there is with the FHA loan, and the monthly insurance is cancelable once there is enough equity. That would mean that the payment on a $400,000 home could drop by as much as $500 when the mortgage insurance disappeared.
This is an important difference. If the market appreciates at a modest 4% per year, the 3% down payment you made at the beginning would turn into 20% equity in less than four years.
Don’t Forget About Closing Costs
You may remember from buying your home that you needed more cash than the required down payment; you had to pay closing costs. For a purchase with a 3% or 3.5% down payment, the closing costs can be nearly as much as the down payment itself. This could mean $20,000 or more to buy a $400,000 home.
4 Creative Suggestions
If your present home is light on equity, you’re going to have to find some creative ways to fund your new home. Here are 4 suggestions:
- Did you serve in the military? If so, you may be eligible for a home loan guaranteed by the Veterans Administration. This loan requires NO down payment, and there is no mortgage insurance. We have often been surprised to meet homeowners who were unaware that they qualified for this exceptional financing.
- Borrow against a retirement fund. Although you will have to make monthly payments on this loan, those payments won’t be considered in calculating your debt-to-income ratio. After all, you are just borrowing money from yourself.
- Liquidate part of a retirement fund. If you are unable to borrower enough cash from your retirement fund, consult with your tax advisor about the cost of liquidating some of it. You may decide that it is a good trade-off to get you into your newer home.
- Find other assets to liquidate. Do you have surplus vehicles you seldom use? An RV or tent camper? Selling a motorhome that you only use once or twice a year could be another way to generate cash to get you to your new home goal.
You may also think about waiting to get more equity in your home as it continues to appreciate. This is a reasonable approach, but keep in mind that as your home goes up in value, the home you’d want to buy is doing the same thing.