Second Trusts; Bridge Loans; Sell First? Sell Second? Juggling the Equity Equation
In a perfect world, every real estate transaction would fall into place like an alignment of dominoes, with each closing date perfectly in sync with the next so that buyers smoothly sail from one home to the next without a glitch. The fear of being unable to coordinate a home sale and purchase or to have the cash to pave the way for an easy transition keeps many would-be move-up buyers out of the real estate market.
“Lenders do have options, but they depend on multiple factors such as the equity the borrowers have in their current home, their credit and their income.”
When inventory is tight, move-up buyers worry that they won’t be able to find a home to purchase. When inventory is plentiful, the opposite concern – being unable to sell their home for the price they need to make a move – keeps move-up buyers awake at night.
Fortunately, lenders have options for either scenario. As a Realtor®, your knowledge of these options can help overcome the concerns of homeowners who are wavering between jumping into the market or not.
As purchasers, your clients are better off if they can make an offer without a sale-of-home contingency, particularly if there are other offers, says Victoria Gillespie, senior vice president of enterprise marketing in the Realtor’s® division of Northwest Federal Credit Union in Herndon and also a licensed Realtor®.
In some cases, sellers who want to move-up can make the sale of their home contingent on finding the home of their choice within a particular timeframe. If their home is desirable, it’s possible to find a buyer who will accept that condition.
“If the market is less frenetic or the home someone wants to buy is in a neighborhood where homes are a little slower to sell, sellers still sometimes accept an offer contingent on the buyers’ selling their home,” says Gregg Busch, vice president of First Savings Mortgage Corp. in McLean. “But this depends a lot on whether the sellers’ listing agent feels the buyers’ home can sell fast enough. That listing agent will make sure the buyers’ home is listed aggressively and will also likely keep the sellers’ home on the market to accept back-up offers.”
Some homeowners feel more confident about their finances if they sell their home first and are even willing to move twice and put some of their possessions in storage. For homeowners who would rather not sell and move, , there are ways to make the transition easier and allow for a non-contingent offer.
“Every situation is different, so it’s essential to map out every possible scenario, including the worst case scenario to figure out the best solution for move-up buyers,” says Marv Stanger, vice president and senior mortgage lending officer of Chain Bridge Bank in McLean. “Lenders do have options, but they depend on multiple factors such as the equity the borrowers have in their current home, their credit and their income.”
BRIDGE LOANS AND CROSS-COLLATERAL LOANS
Bridge loans, which are short-term loans meant to help homeowners transition from one property to the next without first selling their home, essentially disappeared post-housing crisis, but the loans have made a comeback in recent years. Community banks and credit unions that have some flexibility in their loan products and guidelines are more likely to offer a bridge loan than a larger bank, in part because these local lenders know the value of homes in Northern Virginia and the pace of sales.
“Every situation is different, so it’s essential to map out every possible scenario, including the worst case scenario to figure out the best solution for move-up buyers.”
MVB Mortgage started offering a “cross-collateralization” loan approximately 18 months ago, which is a variation on traditional bridge loans designed to meet the needs of move-up buyers in this region. The loan is based on the value of both the current home and the future home of the borrowers.
“Like a regular bridge loan, our cross-collateral loan allows you to borrow money for the down payment on your next home from the equity in your current home,” says Jay Richardson, vice president and senior loan officer of MVB Mortgage in Fairfax. “The main difference between our loan and traditional bridge loans is that we qualify borrowers only on the end loan, not their existing mortgage or the bridge loan, because we know they’ll pay those off when their home sells.”
Richardson says the cross-collateralization loans are a good fit for borrowers who have significant home equity in their current home and good credit, typically at least a 700 credit score.
“People are eligible for this loan if they are putting at least 20 percent down on their new home and have at least that much home equity on their current home,” says Richardson. “They can keep our loan for up to 12 months and make interest-only payments on the loan during that time to make it more affordable.”
When the borrowers’ home sells, they use the funds to pay off their current mortgage and then refinance the cross-collateralized loan into a permanent end loan. The borrowers pay closing costs, including an origination fee on the cross-collateralized loan and an origination fee on the end loan, which makes this option a little more expensive than a traditional bridge loan.
“Borrowers with a high income of $250,000 or more are likely to be able to qualify for a traditional bridge loan, so sometimes we do those instead,” says Richardson. “If their income is $125,000 and they want to move up, the cross-collateralized loan may be their best option.”
A traditional bridge loan requires a credit score of at least 680, says Busch, as well as home equity of 35 percent or more. More important, borrowers need to qualify with sufficient income to make payments on their current loan, the bridge loan and the mortgage on the home they’re buying. The bridge loan payments, Stanger says, are interest-only payments that don’t require any escrow for property taxes or homeowners’ insurance, since those fees are covered by the regular mortgages on each home.
“These loans fall under Qualified Mortgage (QM) guidelines, so the total of their debt payments on all three mortgages as well as any other debt must be 42.99 percent or less of their monthly gross income,” says Busch. “Sometimes we can make an exception to our usual qualifying guidelines for borrowers with less home equity or weaker credit if the home is already under contract or is in a hot neighborhood where it’s likely to sell.”
Recently Busch says a couple moving up into a large home had a debt-to-income ratio well above 43 percent when he included their current home, the bridge loan payments and the mortgage on their new home.
“We made an exception for them because they were very strong buyers with a lot of equity in their property,” says Busch. “We made sure they had their home on the market at a saleable price and that we hold both their bridge loan and the first trust on the home they’re buying. They’ll refinance out of the bridge loan and into the permanent loan as soon as their home sells.”
While that transaction increases the closing costs for the buyers, since they’ll have two closings, sometimes lenders are able to waive some fees to lower expenses.
“We need to get a Realtor® involved right away so we can be realistic about whether the home will sell and the loan will be repaid within 12 months,” says Stanger. “We want to know if the home has been on the market for a while and the probability of it selling for the price needed to pay off the loans.”
As a portfolio lender, Chain Bridge Bank has the ability to approve loans based on an overall financial picture rather than sticking to mandated guidelines. However, Stanger says that their underwriters are looking at the permanent loan to make sure that the end loan can fit into Fannie Mae and Freddie Mac guidelines.
Busch says that while First Savings is approving many bridge loans these days, 80 percent of them end up being unnecessary because the borrowers’ home sells quickly enough that dual settlements can be coordinated.
Another option for move-up buyers is to take out a home equity line of credit on their home (HELOC).
“They’re using the same equity as a bridge loan but the interest rate and closing costs are often lower than a bridge loan,” says Richardson.
The disadvantage of a home equity line of credit is that it must be in place before the home is put on the market. In addition, once the credit line is used to make the down payment, borrowers must qualify for the payments on their current mortgage, the line of credit and the mortgage on their next home. Not everyone’s income can manage all that debt and keep it to less than 43 percent of their gross monthly income.
KEEPING HOME AS INVESTMENT
For some sellers, getting cash out of their home isn’t essential to buying their next property. Some may prefer to keep their current home as a rental property.
“As long as the homeowners have a formally executed lease, we can treat their tenant’s rental payments as documented income,” says Gillespie. “Since we underwrite all our loans in-house we can be creative with ways to work with our members to qualify them for move-up buying even without selling their home.”
ALTERNATIVES TO BORROWING CURRENT HOME EQUITY
While many people assume low down payment loans or no down payment loans are limited to first-time buyers, these loan programs could be valuable for move-up buyers whose down payment will be funded by the sale of their home.
“We can even do 100 percent financing for move-up buyers and then after they sell their home they can prepay their mortgage with a lump sum to shorten the repayment period,” says Gillespie. “The loan payments will stay the same on the mortgage even after the prepayment, though, unless the borrowers decide to refinance.”
Borrowers who choose an FHA loan for the 3.5 percent down payment or a conventional loan with a 3 or 5 percent down payment will need to pay mortgage insurance on the loan, so it’s important to evaluate those options with an understanding of the cost of those premiums.
Another option for move-up buyers who have enough cash for a 5 or 10 percent down payment is to purchase the home with an 80-10-10 or 80-15-5 plan. The second loan can be repaid immediately after their home sells. However, Stanger warns, while there are no prepayment penalties on these loans, the buyers could have to repay closing costs if the lender paid those costs on the buyers’ behalf and the buyers repay the loan within 36 months.
“Paying off a home equity line early could actually end up more expensive than a bridge loan,” says Busch. “Borrowers just have to compare their options on an individual basis with their lender.”
One other option that Busch says sometimes works is to borrow against an investment portfolio with a line of credit for a down payment. He says there are usually no fees to open the line of credit, although borrowers may have to pay an interest rate of about 3.5 percent until they repay the amount borrowed.
TRID AND MOVE-UP BUYERS
"One other option that Busch says sometimes works is to borrow against an investment portfolio with a line of credit for a down payment."
Despite the fears that the new loan documents and closing procedures could cause delayed settlements, many local lenders and Realtors® say the process has already smoothed out. According to a national survey by ClosingCorp, 70 percent of respondents said their TRID closings went faster than expected. The National Association of Realtors®’ February 2016 survey of Realtors® nationwide found that 10.4 percent of transactions were delayed in the first few months after TRID went into effect, but less than 1 percent were canceled. The survey found that the typical delay was 8.8 days.
“TRID actually helps everyone provide better customer service and helps consumers because they can understand the process and their paperwork ahead of time,” says Busch. The good news for Realtors® is that move-up buyers have multiple options to explore to execute their transaction.
“It’s important to start with a dialog about what’s important to the clients and what’s prompting the move,” says Gillespie. “The ‘why’ comes before the ‘how’ – and then a lender can work with them to assess their buying power and preapprove them for a loan based on a thorough understanding of their finances.”