Whether you’re keeping your first home, purchasing an investment property or selling your starter home to move to your forever home, there are paths to navigate along the way. Once you’ve gotten over the hurdle of purchasing your first home, you know how much work goes into the process and how having a trusted advisor along the way makes it that much smoother. That’s why I thought it would be helpful to outline some financial pathways for you to think about before you make your next move.
Do you need to sell your current home?
Consider your current mortgage and what rents are currently in your neighborhood and the answer might just be, “No!” If you have secured one of those amazingly low interest rates below 4% from a few years ago you are well on your way to being able to easily cover your mortgage. Last month, rents on average were 3.4% higher year over year and that trajectory is expected to continue mostly because of the demand for rentals since home ownership continues to climb out of reach for a lot of people.
Definition of a Second Home
In California, you cannot have more than one primary residence for tax purposes. If you purchase a second home in close proximity to the first, it will not be considered a second home, but an investment. To qualify as a second home it must meet this criteria:
· Used for vacations (such as a beach home)
· Used for work
· A pied-a-terre (small living unit – apartment, condo, etc.)
· More than 50 miles distance from your current home
The distinction is important to lenders and will determine how high their rates are since investment properties typically carry higher rates.
That would not stop you from transferring your primary residence to the new property and designating that your primary residence, but you should discuss with your lender whether or not it will affect your rates. Lenders will consider how much equity you have in your first home and your cash reserves to ensure that you can carry the costs of two properties.
Finance Options
The upside of applying for a second mortgage is that it is usually quicker than the first time.
You can choose from the following options:
· A home equity loan (from your current property) – This is usually only ideal if you have no mortgage or you need a bridge loan to carry you until you can pay it off as it is usually a higher interest loan.
· A second home mortgage – You can treat the second mortgage as a primary residence which will be secured by a lower rate than other options making this the most desirable option.
· A home equity line of credit (HELOC) on your existing property – typically lenders will allow you to take no more than 80-85% of your appraised home’s value. Again, this will be a higher rate than a new home mortgage.
· Cash-out refinance of your current mortgage – In this situation, you take out a new mortgage for an amount higher than what you owe on your existing mortgage. This loan effectively pays off your existing mortgage and allows you to receive cash for a portion of the equity you have built, which could then be put toward the purchase of a second property. This works well when your debt to income or cash reserves are not enough to qualify you for a second home mortgage.
Debt-to-income ratio will still be a factor in determining your eligibility and your rate so one way to look better on paper is to consolidate any outstanding credit card or other high-interest debt into one low payment using a HELOC or wrapping it into the loan itself.
Cash reserves will also play a factor. You can use retirement income or life insurance policy cash value to bolster your reserves. Don’t forget to take off 30% of the value if you are under the age of 65. Taxes and early withdrawal penalties would play a factor so lenders will account for that.
Improve Your Borrowing Power
Here are some tried and true ways to appeal to lenders and maximize your loan eligibility and improve your rate.
1. Check Your Financial Progress
a. Regularly monitor your credit score. Use budget trackers to set goals and to reduce expenses. Be proactive in setting goals for savings and determine what you need to achieve the monthly mortgage you are looking for.
2. Meet with a lender to explore scenarios
a. A lender can give you some creative solutions, for example, using the equity you have built in your first home to purchase your second. Whether you plan to sell or keep your first home, there are many ways you can give yourself more flexibility and better financial stability.
3. Pay down debt to increase your debt-to-income
a. The higher your debt-to-income (DTI) ratio the higher your rate will be. By paying off debt and high interest loans you will increase your likelihood of qualifying for more and getting a better rate. Ideally your DTI will not exceed 45%.
4. Increase your savings and use a larger down payment
a. A larger down payment will reduce the lender’s risk and therefore make you a more appealing buyer. Not only that, but it will lower your monthly payment freeing up money for unplanned expenses.
If you are looking for solutions for your specific situation, the best thing to do is to start by planning ahead with a professional. We can share the market forecast and help you put a plan together to meet your real estate goals.