Can You Use Your Current House as a Down Payment?

Homeowners often consider leveraging their current property to fund a down payment for a new residence. This article explores methods through which an existing property can contribute to the financial requirements of a subsequent home purchase.

Understanding Your Home’s Equity

Home equity represents the portion of your property you own. It is calculated by subtracting the remaining balance on your mortgage from your home’s current market value. For instance, if your home is valued at $450,000 and your mortgage balance is $200,000, your equity stands at $250,000. This accumulated equity is a valuable asset for a down payment on another property.

Several factors influence the growth or decline of your home’s equity over time. Property value appreciation, driven by market demand and improvements, directly increases your equity. Consistent principal payments on your mortgage also contribute to equity growth by reducing the outstanding loan balance. Conversely, a decline in property values or taking on additional liens against the property can diminish your equity.

Funding a Down Payment by Selling Your Current Home

The most direct approach to using your current home’s value for a new down payment involves selling the property. This process begins with listing your home on the market, attracting potential buyers, and negotiating offers. Once a suitable offer is accepted, the transaction proceeds to closing, where ownership is formally transferred.

During the closing process, the proceeds from the sale are used to pay off your existing mortgage balance. These proceeds are calculated after deducting various selling costs, such as real estate commissions, which range from 5% to 6% of the sale price. Other seller closing costs, including title insurance fees, escrow fees, and transfer taxes, can add another 2% to 5% of the sale price.

The advantage of this method is the immediate availability of funds from the sale. These funds are not subject to new loan terms or interest payments. This approach eliminates the need to carry two mortgage payments simultaneously.

Accessing Home Equity While Still Owning Your Home

Homeowners can access their equity without immediately selling their property through several financial products. One option is a Home Equity Line of Credit (HELOC), a revolving line of credit secured by your home. A HELOC allows you to borrow funds as needed up to a predetermined limit, and you only pay interest on the amount you draw. During the initial draw period, which lasts 5 to 10 years, HELOCs offer interest-only payment options.

Another method is a cash-out refinance, where you replace your existing mortgage with a new, larger loan. The difference between the new loan amount and your old mortgage balance, minus closing costs, is provided as a lump sum of cash. Lenders allow borrowers to cash out up to 80% of their home’s appraised value. This option results in a new interest rate and payment schedule for the entire loan amount, at a rate higher than the original mortgage.

A bridge loan offers a short-term financing solution to cover the gap between buying a new home and selling your existing one. These loans are secured by both properties and are repaid once the original home is sold. Bridge loans have higher interest rates, ranging from 8% to 12%. They provide liquidity for a down payment or full purchase price, allowing a homeowner to act quickly on a new property before their current one sells.

Managing the Transition Between Homes

Navigating the period between selling one home and purchasing another requires careful planning and coordination. Homeowners face a choice between a “buy before you sell” strategy or a “sell before you buy” approach, each presenting distinct logistical implications. Buying a new home before selling the current one offers the convenience of moving directly, but it can lead to the financial burden of carrying two mortgage payments for a period. Conversely, selling first ensures you have the funds in hand for your down payment, but it may necessitate temporary housing arrangements, such as renting an apartment or staying with family, while you search for and close on a new property.

Timing and coordination are important for a smooth transition. Attempting simultaneous closings, where the sale of the old home and the purchase of the new one occur on the same day, can minimize overlap but is often complex to orchestrate. Alternatively, a delayed closing on the new home or a rent-back agreement on your sold property can provide a few extra weeks to facilitate the move. Such agreements typically involve the seller paying rent to the buyer for a specified period after closing, allowing more time to relocate.

Challenges like temporary housing costs, storage fees for belongings, and the stress of multiple moves are common considerations. The involvement of experienced real estate agents and lenders is beneficial in managing these intricate transactions. These professionals can help align closing dates, advise on market conditions, and navigate potential delays.