Expert: Dick Dennis - 2/9/2012

Question
QUESTION: Hello-
I just had a question about the costs of upgrading to a new house when you outgrow your current one.  We have been in our house just about a year, but feel it may be too small soon (more kids coming) and we may need to get a bigger one is a few years.  We bought it for $200,000 and put $40,000 down.  I am just wondering about estimated cost if we were to get a new house after such a short time.  Say we found another house for about the same price or slightly higher.  Would the estimated realtor fees of, say $10,000 (5% of the purchase price) and the estimated $4000 closing costs on the new house have to be paid out of pocket, or would they be part of the new loan that we get?  Does having more equity in the house make  the costs of getting a new home lower?  We don’t have a lot of money so just trying to figure out how expensive it will be.  Thanks for your help!

ANSWER: Of course, Lisa it'll depend upon the status of the real estate market at the time you decide to sell your present house. Each real estate market is a local affair. That is, whatever is going on in your town will most likely be different than what you read or hear about in the next town or a city halfway across the country. Therefore, it'll be necessary for you to become informed on what is happening in your area.

Once you know the value of your house (not necessarily what you want because you may be buying a more expensive home) then you will know the answers to your questions. But let's take a hypothetical situation. Let's say your house will be able to sell for $210,000. Of course, that means the market will have risen somewhat (not exactly what experts are trying to tell us these days).

As the seller, you will be required to pay a 5%, 6% or 7% commission out of YOUR EQUITY. But let's use the example you proposed in your question. So you will be reponsible for paying 5% ($10,500). Plus it will be necessary for to you pay about $2,000 in closing costs as the seller. But let's put it at $2,500, just in case. By the time you do sell, it's two years and your new child has arrived. In paying in on your mortgage you will have added about $5,000 more to your $40,000 equity. So, $40,000 + $5,000 - $10,500 - $2,500 means you will have $32,000 with which to use as down payment less closing costs of about $4,000 on your next house.

So, the seller and bank are going to be getting only $28,000? That must represent 20% of the expected purchase price. So, you will need to find your bigger house for only $140,000! But if you decide to buy a larger house (hopefully) for the same $200,000 you paid for your present house, then you will need to have either more down-payment funds or a second mortgage for $12,000 ($28,000 + $12,000 + 160,000).

If that be the case, since you do not have any additional funds, and assuming you do have good to excellent credit, Lisa, then it will be necessary for you to take out a SECOND MORTGAGE for $12,000 because the bank who lends you the funds for your next house will ordinarily expect you to have 20% of the purchase price. Otherwise, your next house . . . whatever the size . . . will need to cost only $140,000.

So, if your next house is to be purchased for $200,000, you will need to have a first mortgage of $160,000, plus a second mortgage of $12,000.

What I have just laid out for you, Lisa, is something that was happening in most real estate transactions BEFORE the real estate depression hit us. The real estate market at that time was propelled by a constantly rising equity for most property sellers. Most homeowners were required to hold their house for at least five years, not one or two like you are trying to do now. And the likelihood of us experiencing it once again, is not very probable for as long as five years.

My suggestion to you is to investigate the possibility of remodeling your house to accommodate your family's needs . . . maybe adding a room, enlarging an existing room into two rooms, etc. To finance that, you will need to get a second mortgage to pay for it. It's either that or come up with additional funds to buy your next house. Yes, we are in a real estate market that says that whatever equity you do gain in your equity is TO PAY EVERYBODY ELSE. Now you partly know why the real estate market is as slow and drubby as it is. I do wish you well.

Dick Dennis
dixiedee13@aol.com

---------- FOLLOW-UP ----------

QUESTION: Thank you, your explanation was VERY helpful.  So if I understand correctly, we need to stay in our home about 4-5 years vs. 1-2 so that we will have more equity to use for a down payment on the next home.  Is that correct?  When you said in the example that in about 2 years we would have added about $5,000 in equity, is that because for the first few years you are mainly paying on the interest?  Or where did you get the $5,000 from?  Thanks so much.  I have a much better understanding of the process.

ANSWER: In figuring out what your payment may be after paying $40,000, Lisa, the unpaid mortgage of $160,000 starts off, assuming a 4.5% interest rate, that would make your monthly payment about $811 (not including taxes and insurance). In two years your unpaid balance would then be approximately $154,719. If your interest rate is actually higher, then you can move that unpaid balance back up. If, however, your interest rate is actually lower, then your unpaid balance in two years would be less than what I indicated.

In this kind of market, Lisa, you'd be well advised to stay in your home five or six years anyway. Don't be impatient. As long as your income remains good, then be sure to continue to stoke your savings account so that you can have enough to buy your next house with a bigger down payment.

Dick Dennis
CA real estate broker
Lic #00349415

---------- FOLLOW-UP ----------

QUESTION: Thanks so much Dick!  One last question, how do you know how much equity you have in your house at any given time?  Do you recieve a statement from the loan company?

Answer
Starting a month after you closed your purchase and moved in you should have started to receive a monthly statement and coupon. The coupon is used to submit your monthly payment and the statement tells you how much you still owe on your mortgage. You actually won't know, technically, how much your equity is until you start to consider to sell your property. But you could arbitrarily input a sale price and subtract the amount you still owe on the mortgage. That should give you a hypothetical equity. Equity is never actually defined until you sell the property and close. Be well, Lisa.

Dick Dennis