In a perfect real estate world, we would all transition from one apartment to another in a few seamless motions, like a cartoon Tarzan swinging from vine to vine. But even though it really is a jungle out there, swapping apartments rarely happens so smoothly, especially if you’re short on downpayment funds.
A perfect scenario could unfold like this: "Sell your apartment, live in a flex lease rental until you close on the new apartment, then move in. But there are so many factors involved that can make that scenario not happen,” says real estate agent Brad Bateman of Stribling & Associates.
Among the reasons why wrapping up the sale of your first place might not make sense for you: You haven't found a buyer, there is a time constraint (like moving out of your studio before the twins are born), or maybe there is a deal too good to pass up.
When you already own an apartment, your first challenge is likely scraping together the downpayment. Then you'll need to get approved by the board (mostly a co-op issue) and get approved for financing if you're taking out a mortgage.
1. The downpayment
How do you come up with at least 20% of the purchase price to offer up as the downpayment if most of your cash is tied up in the apartment you already own?
Do your own laundry instead of sending it out? Save that proverbial $20 bucks a week by skipping the Starbucks? For a major purchase like an apartment in New York City, none of that is going to do anybody any good.
That’s not to say you shouldn’t tap into the resources you may have had the first time around. If your parents and/ or any other family member can gift you any portion of the downpayment, that is probably the most straightforward way to go according to our experts, and the gift recipient never pays taxes on the gifted money. (The taxes might be owed by the gift giver, but there are exemptions up to certain amounts.)
Think of it as crowd funding. After all, Dodge is selling cars through a “registry” and someone is trying to buy real estate for a museum this way, too. It may be worth a try, especially if you fully intend to pay the money back.
Short of asking near strangers to fund your real estate purchase, though, there are a few other avenues to consider. We’re not saying they are all great avenues, but these include:
Tapping into other assets
Accumulating more debt by taking on another loan against any non-cash assets you may have is probably not an option (if you carry too high a debt burden, you may not be approved for a loan), so liquidating those assets--stock, for instance--may be the way to go.
Bear in mind that although this option could quickly generate a substantial amount of cash, there are taxes and penalties to consider.
Cashing in your retirement fund
Among the most reviled, but not unheard of, options is to tap into your retirement fund. If that seems particularly unpalatable, that’s because it is supposed to be.
The government seeks to discourage people from withdrawing from their retirement funds too early by imposing a penalty of 10% of the withdrawn amount (in addition to the regular income tax).
“That is really not what that money is for. It’s always a ‘red flag’ -- especially for co-ops," says wealth manager David Monberg.
In addition to the financial penalties, be sure to understand the pitfalls as well. For example, while you can take your contributions out of your Roth IRA without being penalized or taxed, you do have to use the money within 120 days of withdrawing it.
However, under the right circumstances, tapping retirement funds may not lead to ruin and damnation, even with the taxes and penalties you will incur.
Say you’re in your early thirties, married, and have been paying into your 401K since you got a job out of college. So has your spouse. If together, you are able to accrue $50,000 for a 20% downpayment by raiding both of your 401Ks, why shouldn’t you do it? If you are young and expect to keep paying into your 401K, you have some time to make up for lost funds. It would be like starting your 401K from the beginning, and all you will have lost is time.
Some financial experts argue that -- if all the other numbers add up -- raiding your 401K may give you the leg-up you need to secure your purchase. The financial rewards may just be enough to offset the drawbacks, which include some penalties, and losing the amount your company contributes to the 401K.
While he's never a fan of taking money out of a retirement fund, says Monberg, "If you absolutely have to do it, it makes more sense the further out (from retirement age) you are. You have to look at job stability. Do they have job stability and income security to make up what they took out.”
He thinks even less of borrowing against a 401K.
“If you don’t pay it back, you pay taxes on it," says Monberg. "And if you lose your job, you need to pay it back right away.”
Taking out a bridge loan
Bridge loans are short- term loans intended to act as that vine that swings you from the home you are selling to the home you are buying. A lender will require that the buyer qualifies to carry two homes at once. Of course there may be a risk that the sale of the current home drags out longer than expected.
And that's exactly why a bridge loan is probably not an option--at least not in New York City.
"No conventional lenders are doing it," says Keith Furer, a mortgage broker at Apple Mortgage Corp. in Manhattan. "It's too risky."
2. Co-op or condo?
To put it bluntly, being low on funds in general makes you an unattractive candidate to buy in a co-op, where prime candidates are supposed to be able to easily carry a mortgage and the common charges. But as long as you can come up with the requisite downpayment, some co-ops may be willing to construct a scenario that can work for everybody. And by everybody, they mean the building.
"Co-op boards are often wary of approving a purchaser who hasn't sold their current home yet," says real estate attorney Adam Stone of Regosin, Edwards, Stone & Feder. "Oftentimes the co-op will at least want to see proof that it is listed for sale or even a signed contract to show it's in contract so they have an assurance that it will soon be sold and the coop applicant won’t have to carry two apartments indefinitely. All this goes back to the big question of whether the purchaser has the assets, income, etc to qualify her to carry this apartment."
That said, "I have not seen a co-op require the current home to be sold and closed in order to grant co-op approval. It's usually a 'yes or no' on the approval without the sale of current home thrown into the equation," notes Stone.
The co-op reviews your finances and assets (including the apartment you are trying to sell) and makes their judgment from there.
“If a co-op thinks an applicant is borderline, it will often ask for six months or one or two years of maintenance paid up front and held in escrow,” says Stone.
That may not be enough for some boards. If the applicant’s financials are such that they can barely afford their intended apartment purchase and the co-op is worried about the sale of the current apartment, they may turn down the buyer.
If by now you’re thinking that a co-op’s fickle fancy may be what stands between you and your next apartment, there may be a simple, though limiting, solution: “A condo deal may make this transaction easier," says Stribling's Bateman.
Technically, a condo building’s only concern should be if you have enough post-closing reserves to maintain your apartment. Some buildings may even require buyers to take out a larger loan to ensure they’ll have enough cash for the monthly charges.
They leave it to you to come up with the cash for the downpayment. Unlike a co-op, as long as you have the money to carry an apartment (and if you didn’t you wouldn’t be looking at it in the first place, right?) they don’t care where the downpayment comes from.
3. Getting approved for a new mortgage when you already have one
If you're applying for a mortgage on your next place while you still hold a mortgage on your current one, you'll need to jump through a few extra hoops, says Furer, the mortgage broker.
First of all, "the bank needs to be certain that you'll be occupying the new place as your primary residence," says Furer, "because rates and loan-to-value ratios may be different for primary residences versus secondary or an investment purchase."
Some banks may want to see a listing agreement, he says, while others demand a fully executed contract of sale.
You'll also need to prove that you can afford to carry both mortgages. If you can't, your loan commitment will be contingent on proof that you closed on your other apartment and paid back that loan, says Furer. Some of his clients close on one apartment in the morning, and buy the next that afternoon. It's a nailbiter, but possible.