Departure Rules Put the Squeeze on Move-Up Buyers

My how things have changed in the real estate market. And perhaps nowhere has the change been more pronounced than for move-up buyers. During the height of the market in 2002 - 2005, move-up buyers accounted for a significant percentage of real estate transactions, perhaps as much as 60% or more.

The process was simple and straightforward; Buyer owns a house, and buyer has equity in the house. Home prices are going up, and homes are selling in a matter of days (sometimes hours). Buyer decides they would like to purchase a larger home, or a home in a better neighborhood, etc. But moving up always causes complications. Should we sell our existing home first, then find a house? That was problematic because you in essence are jumping off a cliff and not knowing where you are going to land. You might have to rent for a while until you find a house. Contingent offers (contingent on the buyer selling their home) were no good because the buyer could not compete against non-contingent offers.

The solution to this quandary was the unprecedented availability of financing at low rates, with relaxed underwriting (yes some of the same conditions that lead to the mortgage meltdown). Often, if the buyer had equity and good credit, they would obtain a home equity line on their existing home to use as the down payment on their new home. They would qualify (again if they had good credit and income) for the purchase of the new home without having to sell their existing home. This scenario would be a win-win for everyone because there was a high degree of certainty that the existing home would sell in the strong market conditions. This allowed the buyer to pull the trigger when they found a good home, and eliminated the problem with double moves and contingencies. This fueled a huge surge in move-up buyer activity, and helped create the strong (some would say artificial) appreciation that we experienced in the Pleasanton, Dublin, San Ramon, and Tri-Valley real estate markets during the boom market.

Scroll forward to today’s lending environment. The market is soft, prices are down, lenders are swimming in defaults and foreclosures, and there is pressure on banks to correct the excesses of the previous market. One of the adjustments lenders have made involves move-up buyers. Lenders have tightened the process considerably, making it difficult if not next to impossible for move-up buyers to purchase a new home without selling their existing home first.

If you qualify for both mortgage payments together, you are fine, assuming your credit is good. However, this is a very difficult thing to do for most buyers in high priced areas like the Tri-Valley. For example, let’s say you have an $800,000 house and a $400,000 mortgage, and you want to purchase a $1,200,000 house. Of course, you will generally have to have the minimum 25% down on the replacement house in savings or other assets. With this scenario, the buyer would be looking at approximately $9000 - $10,000 per month in total debt between the two homes including property taxes. This means to qualify, the buyer would have to earn $30,000 or more per month. Now of course if the buyer has strong net worth it can still be done, but thanks to the stock market decline many of us don’t have the net worth that we used to.

In the event the buyer does not qualify to carry both mortgages, then buyers usually look to show rental income on their current home to offset the mortgage payment. But lenders have instituted new “departure residence rules”. Simply said, most lenders now require a minimum of 30% equity in your departing (existing) residence or they will not do the loan. Period. There have been many cases of buyers being underwater on their current home, and purchasing a new home, then simply walking away from their existing home (a tactic known as “buy and bail”). Lenders now require an appraisal on your existing home, and you must demonstrate at least 30% equity for the lender to provide financing on the new home. And if you do have 30% equity and plan to use rental income to offset the mortgage payment, lenders will only count 75% of the rental income to offset your mortgage. And if that is not bad enough, most lenders now require 6 months of mortgage payments for both houses as reserves (on top of your down payment).

As a result of these changes, moving up into a larger home has become much more difficult. Move-up buyers today usually have to sell their home first to qualify for a new home they want to purchase, which creates some obvious complications. What if the home we like gets sold before we sell? What if we sell and there are no good houses available? And the market has seen the impact, especially in the $1,000,000 and up market. There just is not the same pool of buyers to draw on in the current market, and prices have slid as a result. The good news is that if you are committed to moving up, and willing to sell your home first, there are some incredible deals available in the $1 million plus market. As is often the case, those who take bold action in uncertain times will win.