options for down payment on next home

[mrWinter]

I'm getting closer to buying our next family home, and selling my current one. I'm still in my working years, ~20 years to go before retirement if the plan goes well. My hope was to save enough cash to pay the down payment from that stash but it's looking like we aren't going to have enough saved by the time we'd like to move. So I'm now looking at other options on the table to make the switch work. Also something to note, I'd like to keep the option open of doing a construction loan and rehabbing the next house. I did that on my current place so have an idea of what is entailed, but it means I wouldn't be moving out of my current house for a minimum of 6 months I'd think, so couldn't sell the current house at or around the same time as I buy the next one.

I see 4 options below, which I've ranked in order of preference, first is best as I'm currently thinking. I'm soliciting opinions here on if there are any other pros or cons I've missed from these options or if there is another option on the table I haven't considered.

Background info:
current home relatively safe value estimate: 350k
current home remaining principle: 225k
current home equity: = 125k
estimated closing/sale costs: 10% = 35k
estimated cash left after sale at estimated value = 90k
additional amount desired for 20% down payment on next home: ~50k


1) Borrow from 401k, after I buy new house and get moved in, sell old house, and pay off balance.

Pros:

• no effect on credit report
• no effect on current income to debt ratio
• no real interest paid (you apparently pay 'interest' but you are paying it to yourself, I don't understand why but ok)

Cons:

• Money is out of the market for however long it is before I sell my current house losing those gains, although also possible that money would be saved from losses.
• If current house sells for significantly less than I expect then maybe I wouldn't have the cash after sale of current home to pay down the loan and money would stay out even longer. I think this is unlikely given the numbers in the background info, I'd need to pay off 50 k and expect to have at least 90k after sale of current place The real estate market could fall 10% and I'd still be fine.
• If things go completely belly-up and I don't pay off the loan it becomes a distribution and I get penalized, pay taxes, and the remaining money is no longer in tax sheltered retirement funds. I'd have to get fired for this to happen though, as the payments automatically come out of my paycheck until the loan is paid. Things would then be going bad enough were that to happen that the lost 401k loan would be a minor concern in the big picture of what was going on with my financial life though I think.

2) HELOC (Home Equity Line of Credit)

Pros:

• no risk of losing out on big market gains with a 401k loan, but also no potential to miss out on market losses

Cons:

• interest payments prime + 0.8, currently 6.3%, possibly 4% for first year
• negatively effects income to debt for purposes of loan approval (if doing construction where I'll own two homes at once for a while, the bank needs to be happy with me having total debt of both mortgages and the HELOC at the same time for a period of time)
• short term negative effect on credit score

3) Pay less than 20% down and accept PMI

Pros:

1. no need to take either of the above loans, I have enough cash to pay ~15% down.

Cons:

1. interest rate on mortgage will be higher for life of mortgage (unless I refinance which would incur more refi/closing costs)
2. PMI will cost money until I sell the current house then use proceeds to pay down mortgage balance to get 21% equity at which point PMI is automatically dropped. Doing the math it looks like the PMI would be a bit more expensive (~1.5k if they were both held for a year) than the HELOC interest over the same period.

4) Make the offer on the next home contingent on the sale of my current home

Pros:

• By making the sale contingent I effectively couple the two transactions. I sell my current place and then use the proceeds to pay down payment for next house. No liquid cash needed right now to make it work.

Cons:

• Can't do any rehab projects as the sell of current home needs to happen right at the same time as purchase of new.
• Offer is significantly less attractive to seller - they are accepting risk that I won't be able to sell my place in which case the deal falls through. I'd have to make my offer higher to make it as attractive as other non-contingent offers.
• Seller may respond by putting in a right-of-first refusal in sale contract, meaning they can cancel the deal anytime if another better offer comes along, unless we right away make good on the moolah. That would really stink if while scrambling to sell my current place someone else comes along with an offer they like better and say they will bail on me unless I can get the cash and close in a couple days.
• This would be much more stressful than the alternative decoupled purchase and sale.
• In order to make the deal on the next purchase go through I'd need to sell my current house in a month or two, accepting whatever offers I got during that time, I might end up selling the house for less than otherwise.

So yes, my favorite option is to borrow money from my retirement account. I won't be surprised if I catch some flak for this on an early retirement forum but the numbers and risk just seem to look the best of all the options. Really the only downside is that I'd potentially miss out on market returns during that period, but considering that I also may miss out on losses, and that I can't predict the future that's not so bad.

Any info on things I may have failed to consider or other options I'm not aware of are appreciated. Long post, thanks to all who made it to the end.

 

[bloom2708]

#4 is still the best option unless you are in the Hottest of Hot markets.

Don't fall in love with any house. Then if your offer is rejected, just move on to the next house. Lots of houses out there for sale.

 

[mrWinter]

Thanks bloom.


Surprised no more have had any thoughts on this but maybe I'm just not as interesting as I hoped. Maybe I just fell off the new posts stack. Bumping here.

 

[Bamaman]

#4 is still the best option unless you are in the Hottest of Hot markets.

Don't fall in love with any house. Then if your offer is rejected, just move on to the next house. Lots of houses out there for sale.

I have never been a fan of borrowing against a 401K, as they're best just left alone. I agree with #4, in not making it a purchase of the heart. Buying a home is best when it's a business decision. Like was said, there's always other houses out there for sale.

Alternative financial arrangements should be reserved for when you find a home that's such a bargain that it cannot be passed up.

We purchased our home as a foreclosure for a very low price--one of the few foreclosures locally in good condition. Fortunately I had the cash to lowball the credit union holding the mortgage and could make a quick closing. Then we took our time reconditioning the previous home in order to get top dollar.

 

[pb4uski]

Option 5.... defer until you have $50k saved in taxable accounts so you can do a clean buy contingent on the sale of your current home.

You say you have 20 years to go and are planning to move from a $350k home to a $700k home. That $700k home may well be an anchor around you neck if you have any dreams or plans to RE.

Or put another way, if you have to go through the financial gymnastics that you outline in the OP to move, perhaps you can't afford to move at this time.

FWIW, when we bought our family home in our 30s we paid about twice what we were making at the time... we stayed in that house for 25 years and when we left I was making more than its value (and that was at 50% part-time).

 

[The Cosmic Avenger]

I agree with pb4uski. And I would rank your options in the opposite order, because the first two have a remote but real chance of catastrophic failure. Sure, it's probably worth the gamble that you won't hit any huge financial potholes like loss of income or an emergency home/medical expense, but I think it's prudent to avoid those situations.


Leveraging debt instead of saving can be a useful tool. I'm considering taking out a mortgage for a retirement home instead of using existing equity, but that's because I expect to have 30-40 years in retirement. IMO leveraging debt when you don't have the cash to pay it off is like day trading -- higher risk, higher reward, but even that small chance of failure is not really worth betting your whole retirement on.

 

[ivinsfan]

Option 5.... defer until you have $50k saved in taxable accounts so you can do a clean buy contingent on the sale of your current home.

You say you have 20 years to go and are planning to move from a $350k home to a $700k home. That $700k home may well be an anchor around you neck if you have any dreams or plans to RE.

Or put another way, if you have to go through the financial gymnastics that you outline in the OP to move, perhaps you can't afford to move at this time.

FWIW, when we bought our family home in our 30s we paid about twice what we were making at the time... we stayed in that house for 25 years and when we left I was making more than its value (and that was at 50% part-time).

Yep and Yep, and you were "hoping" to have the 20% down to put toward the new house but you don't. WHY don't you? What kept this from happening? Stop and think and then stop and think again why just continuing to save for the DP is not a viable option. You are going to lay out that much money for a house that needs major remodeling?

And BTW you don't have to get fired to trigger 401 payback your company could just downsize, you could get hit by a bus, become ill or even divorced ..

And BTW PMI has changed a lot since the housing crisis don't count on it going away with a 21% equity.

 

[Senator]

You likely will not be able to use a HELOC unless you can manage the payments for both the new mortgage and the HELOC. The bank underwriters may count the entire HELOC payment, not just the interest.

The HELOC interest for the down-payment should be deductible, as it was used for buying a permanent residence.

Then, rent the former house out, do not sell it. You need to be able to afford both mortgages.

It appears to me you are not financially ready to purchase another home.

 

[Cichon_007]

.....My hope was to save enough cash to pay the down payment from that stash but it's looking like we aren't going to have enough saved by the time we'd like to move.

Option 5: Realize you can't afford a $700k house right now.

You didn't say anything about the rest of your situation, other cash reserves, other investments, income etc. But you mentioned the HELOC counting against income qualifying for the new loan. If taking that $50k HELOC is going to put you at the upper income/borrowing limits for the new place, you can't afford it.

 

[mrWinter]

Thanks for the replies. Guess I'm surprised by what I'm hearing but that means it was a good thing I asked!

To clarify a few things:


The next house purchase I'm looking to spend ~600, not 700. If it's a rehab job the purchase price would be less than that. Yes, in my state it is not hard to find a half mil house that needs work.

Yes 600k is a lot, but by my math and future projections we can afford it and it will not kill ER dreams. Agree less is better, but I'm of the saving mindset, if anything I'm risking saving too much now and having a bigger pile at retirement than needed while not having lived as much as I and my family would like during the working years. I'm trying to balance that and I think this budget is within that balance.

I'm not trying to take a loan to leverage debt and buy a bigger house, the debt instruments are all short term, just a means to conveniently transfer equity in my current home into the next home.

While I have not been pre-approved, I believe I will qualify in the bank's eyes for supporting both mortgages, and a potential HELOC, all at the same time. I don't personally want to suppoort both mortgages (unless I were renting one) and I don't intend to hold both any longer than any rehab may take to do.

Yes it would be nice to rent out the current house after I move out, I have considered it, but am leaning towards not being a landlord as with two little kids time is already on short supply, and the risk of renters messing up my place scares me.




What I'm surprised by is that to some it seems the only reasonable option is to save enough to pay the down payment on the next house cash. While I certainly recognize this is the ideal, I also would think it the exception and a much better than 'normal' position to be in. Is it true that most people really save all that cash before buying a next house? My thinking was that most took some kind of bridge loan or made a contingent offer. Otherwise they have to go through the difficult task of saving all that cash for a down payment for every house they buy in their life, rather than transferring equity form one to the other.

When the current house sells and I get equity out what should I do with that? Pay down the new house mortgage so I have 30-40% down? Certainly would be a nice option but I'd personally rather invest the money.

I could have over the last several years saved more cash for the down payment, but I'd rather that money go into tax advantaged investment accounts so I've been pumping into retirement accounts more. If I can transfer the equity from my current house and have a little after-tax investment money available, I'd rather do that than put less money into retirement accounts so I can save put the cash into the next down payment, then sell the current place, and then be sitting on a bigger pile of after tax cash. Hopefully that makes sense.

 

[mrWinter]

Yep and Yep, and you were "hoping" to have the 20% down to put toward the new house but you don't. WHY don't you? What kept this from happening? Stop and think and then stop and think again why just continuing to save for the DP is not a viable option. You are going to lay out that much money for a house that needs major remodeling?

Rephrasing what I said in the last post, but to answer, I didn't save enough cash because I prioritized putting savings into tax advantaged retirement accounts rather than after tax investments or cash reserves, knowing that I have enough cash + equity in my current home to cover the down payment for the next if needed, and presuming I'd be able to utilize it.

And BTW you don't have to get fired to trigger 401 payback your company could just downsize, you could get hit by a bus, become ill or even divorced ..

Agreed, but 1) would a hardship withdrawal apply then so penalties are not applied? and 2) If I lose my job and can't get another one immediately, or am hit by a bus or seriously ill, or divorced, the early withdrawal penalties applied to that 50k are the least of my worries. That will be a drop in the bucket.

And BTW PMI has changed a lot since the housing crisis don't count on it going away with a 21% equity.

Do you have a source on this? I read multiple sources that said PMI is dropped automatically at 21% equity. - Correction 22%


From Bankrate -

When the balance drops to 78 percent, the mortgage servicer is required to eliminate PMI.

 

[RunningBum]

What I'm surprised by is that to some it seems the only reasonable option is to save enough to pay the down payment on the next house cash. While I certainly recognize this is the ideal, I also would think it the exception and a much better than 'normal' position to be in. Is it true that most people really save all that cash before buying a next house? My thinking was that most took some kind of bridge loan or made a contingent offer. Otherwise they have to go through the difficult task of saving all that cash for a down payment for every house they buy in their life, rather than transferring equity form one to the other.

Most people don't plan to hold onto two houses for very long like you are. I've always bought my next house on contingency, until I was in FIRE shape and could afford the overlap. Maybe I was lucky enough that they accepted it, and I was able to close both on the same day and have a few days rent back on one end or the other to move my stuff.

I know of one friend recently who really wanted this new house and bought it with no contingency. Couldn't get their old house sold and rented it out. The renters had pets that caused more damage than the deposit--not trashed, but not in good shape. The guy wound up driving Uber to make ends meet until they got the old house sold. Not a fun time for him.

You're in even shakier shape in that you don't want to move into the new house until you fix it up, so you don't have the rental option off the bat. But it sounds like you're in reasonable good financial shape that you can afford both for awhile, and are just trying to find the best way to do it.

You say if you lose your job you'll have bigger problems than the 401K loan but I don't know why you'd want to add to the problems. Plus you might get another job quickly, but still be stuck with that 401K distribution. Maybe you feel your job is really stable for the next year or two.

What's the mortgage rate difference between 15% down and 20% down? What's it really costing you per month after you sell the old and increase equity to remove PMI? If it's not too much I'd go with that as the cost of reducing risk. If you want good responses, you really need to give full information on the options. You seem to be slanting the discussion and people aren't buying it.

I agree with your response about renting out the old house. That's not a solution to your situation of what to do while remodeling the new house, and once you've moved into the new house you don't need the headache of being a landlord. Some people don't really take time to comprehend a situation and just reply with their own canned response based on their own preferences. Not helpful.

 

[pb4uski]

.... Make the offer on the next home contingent on the sale of my current home

Pros:

• By making the sale contingent I effectively couple the two transactions. I sell my current place and then use the proceeds to pay down payment for next house. No liquid cash needed right now to make it work....

That's not really right is it? Your proceeds from the sale of the current home is $90k ($125k equity less $35k costs) and to put up 20% on a $600-$700k home you'll need $120-140k... another $30-50k... where will that money come from?

Unless you wait until you have that $30-50k saved, it looks to me that even if you go with making a purchase contingent on the sale of your current home that you'll still need PMI.

Even if you borrow from your 401k at the end of the move you would still have $30-50k remaining to pay back over time and if something happens and the loan gets called then you're stuck or may have to get a HELOC to pay off the called 401k loan.

That said, 10% for costs sounds high to me.

 

[skipro33]

My son bought his second house last year in a hot market and immediately put his current home on the market. You guessed it; the market went cold. Took him 8 months to sell the first home. 2 mortgages for 8 months. No renter, no income at all from the first house. All the homeowner expenses; property tax, insurance, upkeep of landscaping, etc. That makes me think #4 is best. It's the only way I've ever bought a new house; on contingency. BUT, I put the first house up for sale before I found the second house and I had a buyer for the first house before I had a contract for the second house. I still had the second house written up as contingent because deals fall through and if the first house deal fell through, I wanted a way to back out of second house deal without loosing my down or good faith money.
I have borrowed on my 401K when I was building a new house and ran short to finish. $50K. I got lucky and this was in 2007 just before the market took a nose dive. I retired in 2012 and took the remaining loan balance as a draw that year on my taxes. The problem with borrowing on a 401K is if you loose your job, it's due or considered a draw. If you are too young, there's penalties. That's a pretty big risk. No one anticipates loosing their job, but it happens all the time. Don't get caught that way.

 

[The Cosmic Avenger]

1) would a hardship withdrawal apply then so penalties are not applied? and 2) If I lose my job and can't get another one immediately, or am hit by a bus or seriously ill, or divorced, the early withdrawal penalties applied to that 50k are the least of my worries. That will be a drop in the bucket.

That's the thing, if you're conservative and a little cash-heavy, you can also turn what would be a disaster into just a minor setback. I've had two five-figure emergency bills so far this year, and we cut back on our spending and "borrowed" from the cash we were saving up for other things, which we'll be able to pay back before we need it. So I think what some of us are trying to tell you is, don't stretch yourself for higher gains if you're risking turning that setback into a disaster.

I'm not saying you were wrong to invest that cash instead of keeping it set aside, but if you have to pull it out for an emergency or to swing a home purchase, it's more of a setback for you than it is for me, so again, you're trading risk for higher returns. Nothing wrong with that, if you're fully OK with higher risk. Yes, this board's temperament as a whole tends towards the fiscally conservative...at least until we have plenty of dough to blow! That's because as a whole we tend to be more concerned with minimizing our losses through the next bubble or recession than getting higher returns.

It's a choice, and I think those of us responding understand that you're choosing higher risk for higher returns, but you seem to be glossing over the higher risk part, which is why we keep talking across each other without being able to come to a consensus.

Anyway, whatever you decide, best of luck. Moving is always a pain, no matter how much money you have!

 

[ivinsfan]

OP your bankrate quote on PMI refers to a 78% balance of your original mortgage amount.

FHA loans almost always need to re-fid to get rid of PMI..
Some PMI's come with a minimum term of two years.

So how much cash do you actually have on hand? Do you have a decent emergency fund? From what you say you are either spending the money, funding the 401, and making a current house payment. Is there money left for after tax savings? It sounds tight IMO. You can only put so much money into retirement savings and still be tax deferred.

 

[mrWinter]

That's not really right is it? Your proceeds from the sale of the current home is $90k ($125k equity less $35k costs) and to put up 20% on a $600-$700k home you'll need $120-140k... another $30-50k... where will that money come from?

Unless you wait until you have that $30-50k saved, it looks to me that even if you go with making a purchase contingent on the sale of your current home that you'll still need PMI.

Even if you borrow from your 401k at the end of the move you would still have $30-50k remaining to pay back over time and if something happens and the loan gets called then you're stuck or may have to get a HELOC to pay off the called 401k loan.

That said, 10% for costs sounds high to me.

Apologies to all for not making that clear. I'm sitting on the remainder in cash now. I've got 100k saved up, I want another 50 K to get me up to the 130-140 down payment plus breathing room, furniture, etc.

 

[ivinsfan]

Apologies to all for not making that clear. I'm sitting on the remainder in cash now. I've got 100k saved up, I want another 50 K to get me up to the 130-140 down payment plus breathing room, furniture, etc.

Do you have 100K and some emergency funds..You know that was a pretty detail to leave out.

 

[mrWinter]

If you want good responses, you really need to give full information on the options. You seem to be slanting the discussion and people aren't buying it.

Certainly not trying to misrepresent or slant anything, I thought if anything I was putting in more detail than people would want to hear. Maybe my bias towards one solution over the other, or to the fact that I can even afford it, may be unconsciously steering my comments, but I'm definitely genuinely soliciting opinions not just trying to hear people tell me what I want to.

 

[ivinsfan]

Certainly not trying to misrepresent or slant anything, I thought if anything I was putting in more detail than people would want to hear. Maybe my bias towards one solution over the other, or to the fact that I can even afford it, may be unconsciously steering my comments, but I'm definitely genuinely soliciting opinions not just trying to hear people tell me what I want to.

I don't know about slanting but it seems you want to get a house NOW, why is that?

 

[mrWinter]

Do you have 100K and some emergency funds..You know that was a pretty detail to leave out.

Yes, good point, I hadn't read your post mentioning the emergency fund before I replied to the other. I guess I try and not reveal more details about my exact financial situation than needed online, but perhaps I can't really solicit helpful info if not. In for a penny in for a pound here I guess.



I have 80k in money market and 37k in checking account now. Of that I'd like to reserve 10k for slush fund, leaving me 107 currently in deployable cash. I wouldn't really call 10k an 'emergency' fund, a real emergency fund would be bigger for me, I don't really know what would make me comfortable 60k maybe? So admittedly during the transition period I'd be running lean, in a risky spot, on the highwire a bit, until I sell my house and then get that extra 40k or more to replenish the emergency fund. So yes I do see the risk there, if I or my wife lost our jobs between when we bought the new house, and when we sold the current house, we'd be in a pickle.

 

[pb4uski]

Perhaps you could go with a contingent sale approach to begin with (which you can do right now) and continue taxable saving and once you have the needed downpayment without needing to sell you could shift.

I once had two mortgages for a couple weeks and didn't like the feeling... our existing house was under contract with no remaining contingencies and the real estate agent made us a bridge loan from the buy until the old house closed.

 

[mrWinter]

I don't know about slanting but it seems you want to get a house NOW, why is that?

Doesn't have to be NOW, but sooner rather than later, and summer of 2022 at the latest. Kids will be going to kindergarten then and I want them to be in our next neighborhood for that. I may well happily take a year to move and will by then have saved more, but not 50k. If I take 3 years, then by then I could have saved enough cash, but that's cutting it down to the wire with entering kindergarten, not leaving much time to shop around, and I'm feeling the call of the burbs to move on the sooner side. A quieter street, safer streets for kids, less crime, maybe a little more backyard space, etc. I'm getting hot to trot because we've been looking at neighborhoods and houses lately and I'm getting stoked for a move, but can chill for a while.

I could save more money faster and knock out this whole issue in a year and a half or so if I took a hiatus from, or reduced my retirement account saving, but that seems sacrilege to me. I'd rather put the money in tax advantaged accounts, as opposed to having the money ultimately end up in after-tax funds.

I'm trying now to get my ducks in a row and make a plan in case a good opportunity shows up that I'd really like, I can I move on it, and I know how best to do so. The inventory in the neighborhoods we are looking at is not immense, and rehab opportunities less so. I don't need to move by the end of this year, but if the right thing shows up it would be cool to jump on it, and I don't think the situation will materially change anytime in the next 2-3 years such that I wouldn't need to utilize one of those 4 options, unless I temporarily weaken my retirement saving effort.

 

[mrWinter]

Perhaps you could go with a contingent sale approach to begin with (which you can do right now) and continue taxable saving and once you have the needed downpayment without needing to sell you could shift.

I once had two mortgages for a couple weeks and didn't like the feeling... our existing house was under contract with no remaining contingencies and the real estate agent made us a bridge loan from the buy until the old house closed.

Yes that's good thinking. I have experienced the double mortgage thing before, except one of them was rent for me. When i rehabbed my current home I was renting for those 6 months. Definitely don't love that. And I need to budget for those double payments during that period too as extra cash on hand I'd need.

 

[W2R]

I don't know what you should do. I could be wrong but honestly I don't think there is a right answer because we don't know the future. But anyway, here's what I did.

After retiring, I looked online every day for my "Dream Home" for about four years before I found it. I wanted to buy it in cash, like I had done for my previous home. While looking, I was piling up cash with this in mind.

When I unexpectedly and suddenly found it, I jumped on it and had a full price cash offer in before it even hit the MLS. It was a hot market at that time, so I had to put in an aggressive offer ASAP in order to get the house. I didn't have enough cash piled up yet to cover my offer, so I sold some of my taxable portfolio to get the cash and took a tax hit for doing that due to capital gains. Then after moving into my Dream Home I sold my old house in four days and put most of the money from that sale back into my investments at Vanguard (well, minus the "fix up" costs, closing costs, moving costs, etc).

Probably not smart to take that tax hit! But I *DID* get the house I wanted and as you all know by now, for me that was a Big Deal. Maybe not for others, but for me living in this house has been truly a highlight of my life.

Luckily prices went up in this neighborhood so both Zillow and realtor dot com say my present home is worth more than 150% of what I paid for it four years ago. Not that I'm selling; but the point being that if I had waited to pile up more cash, I would have had to pay considerably more for a house of this type.

In other words, I did not purchase it in an ideal way, but in time it all worked out.