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A two-bedroom, one-bath starter home may work well for a single person. But, add a partner and a couple of children to the picture and you can easily justify needing a three- or four-bedroom, two-bath home. Most first-time buyers ultimately become trade-up buyers as their lifestyle changes.
A trade-up move is more complicated than buying a first home. There are two transactions involved, rather than one. However, the challenge of coming up with the down payment, which stymies many first-time buyers, may not be a major issue for a trade-up buyer.
Most homeowners have seen the value of their homes increase significantly through home price appreciation. In some places, home prices have doubled in the past fix or six years.
Let's say that you bought your home for $300,000 six years ago with $30,000 down and a $270,000 mortgage. Today you might sell your home for $600,000. Your equity is equal to $330,000 minus the costs of selling the home. When this equity is converted to cash, you'll be able to make a sizable down payment on a more expensive home.
Some trade-up buyers have sufficient savings to buy a new home without having to tap the equity in their current home. But, for most trade-up buyers, the biggest dilemma involves how to convert this equity into cash.
There are several options. You can sell your home before you buy a new one. The advantage of this approach is that you know precisely how much money you have to work with. The disadvantage is that you may have to move into a rental if you can't find a home to buy in time.
Another option is to borrow against the equity in your current home, and sell that home after you find a home to buy. This way you avoid having to make an interim move. But if the market changes in between the time you buy the new home and sell the old one, you could sell for less than you anticipated.
You might try to avoid the pitfalls of the above approaches by buying the new home contingent on the sale of the old home. However, to do this, you must find a seller who will accept a contingent sale offer. Contingent sale offers are virtually non-existent in active real estate markets where buyer demand is high.
Deciding on which approach to use will depend on current market conditions in your area, on your personal financial situation and on your tolerance for risk. Consult with your real estate agent and financial advisor before making a decision.
HOUSE HUNTING TIP:
Recent home price appreciation combined with record-low interest rates makes this a particularly good time to make a trade-up move. A trade-up move often involves a larger mortgage than you carried on your starter home. Low interest rates make it possible to qualify for a larger mortgage.
Thirty-year fixed rate loans are available in the low 5 to 6 percent range. Much lower rates are available on mortgages that are fixed for five years. But, as attractive as these loans might be, consider that you might be faced with refinancing in five years at a rate that's significantly higher than today's rate.
THE CLOSING:
In some markets, like the San Francisco Bay Area, home prices have softened on more expensive properties, but have remained strong on lower-priced properties. It's in these markets that trade-up buyers have a distinct advantage. There may be high demand for the less expensive home you're selling and less competition for the more expensive home you want to buy.
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