How To Buy Your New House Before You Selling Your Current Home Strategies
When buying a house and having one to sell, strategic planning is critical. Real estate has always been a highway to financial security and preparation for the future. This blog will demonstrate to you why paying 20% down isn’t always the best option. Please keep in mind the purpose of this information is to teach you some great strategies you may wish to employ.
There’s a lot here to digest! Go slowly, if you skip, you’re more likely to get confused. There’s very little fluff here. Let’s first start by determining a strategy based on your long-term goals.
Know Your Objectives
- Where do you want to be with your family and finances?
- What are your goals in the next 6-12 months?
- When do you want to move into your new home?
- How much time do you have to move based on selling your house?
So you want to buy a house before selling your current home. There are three ways to eliminate PMI from your mortgage. The first method is a large pay downpayment.
The seller has accepted your offer contingent on the sale of your existing house. You’d like to put 20% down to avoid PMI using the net proceeds from the sale of your current home. Using the scenario illustrated below, let’s assume your upgrading to a larger home and have a buyer for your existing home. The purchase price is $250,000, you have $5,000 in savings and $42K from your 401K.
- Purchase Price: $250K Contingent
- Taxes: $3000
- Current Savings: $5000
- 401K Balance : $42,000
- Net Proceeds From Sale of Existing House: $55,000
- Seller Concessions: $0
- 20% Downpayment $50,000
- Cash to Close with closing costs: $60,234
In the illustration above, you’ve used up all of your net proceeds plus your savings to make up the $50,000 (20%) downpayment and cover closing costs. Leaving you with no reserves for emergencies. However, your IRA remains intact.
In this scenario, your current debts are:
- $14,316 Atudent loans
- $7,547 Car loan balance
- $7,194 Quad Runner loan balance
- $3,783 Credit card debt
Having used up all of your savings and net sale proceeds, your debts remain the same (car & student loans & credit card) and your total monthly outflow has increased by another $163 a month.
You might be thinking that’s acceptable but I’m here to show you that there are better strategies you can use that will place you in a much better financial situation even after you’ve purchased your new home.
Using The 5% Strategy
Although buying out of PMI at the closing table will save you 50% in costs, sometimes we can’t always take full advantage of that. Keep in mind that PMI is not permanent on conventional loans.
- 5% down payment PMI falls off in 84 months or 7 years.
- 10% down payment PMI will fall off in 60 months or 5 years.
- 15% down payment PMI falls off in 36 months or 3 years.
- 20% down payment no PMI
Over the last couple of years, the market has been and remains competitive with homebuyers often bidding against each other for the best properties. The strongest purchase offer is one that is non-contingent. That is, the seller is guaranteed to close regardless of your current house selling or not prior to the closing date. Using the 5% down strategy can give you enough flexibility to make a non-contingent offer on your new house.
Let’s look at how paying down 5% instead of 20% will affect your payments on the purchase of a $250K house, $3000 taxes and asking the seller for a concession of $5,000 used towards your closing costs.
The 5% strategy allows you to buy non-contingent of selling your existing house, a much more attractive offer to the seller. So where do we get the money to buy 5% down without selling your current home and having only $8000 in reserves?
Here’s the overall strategy:
- Take a temporary loan from your 401K for $17,000. These funds get you into your new home.
- Sell your existing house and net $55,000.
- Pay back your 401K loan of $17,000.
The beauty of it is that using this strategy wisely places you in a much stronger position financially than if you had to use up all of your savings and net proceeds or a significant chunk of your 401K to put down 20%.
Using the 5% strategy, your cash to close is $42,500 less than if you put 20% down in the example above. Using the 5% strategy means you only need to use $17,734 from your 401K, reducing your tax liability.
After the sale of your existing home, you can always replenish that amount back into your 401K again. In this scenario, your net proceeds from the sale of your existing house are $55,000. Leaving you with $38,000 in your pocket ($55,000 proceeds – $17,000 payback into your 401K).
Take Steps To Further Improve Your Financial Position
Now, remember that the difference between 20% and 5% down was $233 a month? Seriously consider using enough of your remaining net proceeds to pay off your car loan, student and/or revolving credit loan so as to reduce your monthly expenditures as much as possible.
Although the diagram shown below eliminates the student loans as well, given the choice between credit cards and student loans, always pay off (or pay down) the highest interest rate loans first which are typically credit card debt. Student loans tend to have very low-interest rates, so I personally would leave those last.
In the illustration below, you’ve used $29,316 of the $38,000 net proceeds and paid off the car loans, student loan, and outstanding credit card debt, leaving you with $8,684 still in the bank. Now your total monthly outflow goes from $3,681 to $2,616, saving you $1,065 every month.
PMI Buy Out Option
Say you found a buyer for your existing home and managed to arrange to close the sale prior to closing on the purchase of your new home (allow 48 hours for wire transfers). Your first step, call your lender!
Ask him/her how much to pay off your PMI at closing and lower your monthly mortgage payment even further. When paying off your PMI at closing, you’ll be given a 50% discount! This is the only time the discount can be applied.
Keeping consistent with our illustrations, you’ll use $2,664 from the remaining $8,864 sitting in your bank account to pay off PMI at the closing of your new house.
Now you’re really sitting pretty! You’ve bought your new house with only 5% down…
- restored your 401K
- eliminated PMI
- reduced payment by $53/month
- still have $6,200 in the bank
- reduced your monthly outflow by over $1000
- improved your credit by paying off some debt
By contrast, had you paid 20% down, you would have lowered your payment by $233 month, used up all of your net proceeds from the sale of your existing house plus the remaining $5,000 from your savings and increased your monthly outflow by $233.
Shorten Your Term & Keep More Of Your Money
The fastest way to dramatically reduce your interest paid and shorten the term of your loan is to make pay more than your minimum. Having now eliminated your big loans and credit card debt, your PMI and significantly lowered your monthly costs using the 5% strategy, you can use some of that extra cash in your pocket.
For instance, just by paying an extra $200 to your principal each month, you can shave off eight years. You could have your house paid for in just 22 years vs. 30 years saving you $121,250 in interest and principal. Which still leaves you with $800 positive cash flow every month.
If the cost of buying out of PMI at closing without first selling your current home is still too high, there is another option. It’s called Recasting the loan.
When you do sell your old home you can then inform your lender you sold your old home and now want to send in the amount is needed to buy out of PMI. You can add on as much as you want to lower your mortgage payment at this time as well. Then bank is happy to take your money!
If you decide to send in more than what’s needed to pay off the PMI, be sure to tell your lender you want this money applied to your current mortgage balance. This causes your loan to re-amortize for the remainder of the loan. This will also have the added benefit of reducing the total amount of interest you’ve paid over the life of the loan.
Refinance Vs Recasting
Some may say that you’re better off refinancing the mortgage. The problem with that is cost. When refinancing you will incur higher costs and fees and could also be subject to any current market rate changes.
When you recast your loan, you avoid all the costs related to refinance and keep your rate intact while still lowering your principle and eliminating your PMI (or at least reducing it). This is a powerful option helping you to prevent the mortgage company from obtaining another transaction charge from you.
Your Two Cents
I realize there’s a lot here to digest and I tried my best to lay it out as best as possible. I encourage you to also check out How To Avoid PMI for another strategy. Your feedback is always welcome. Let me know if I can be of any help.