Imagine a hypothetical scenario: you own a home or condo free of any mortgage. You want to sell your home (for whatever reason) and you have a new home picked out. If you sold your current home, you would be able to use the proceeds from the sale to significantly reduce the amount of the mortgage on your future home.
Real estate lawyers are legal advisors, not strictly financial specialists, but some free advice: follow the percentage.
Average Mortgage Rates for Purchasing a New Home
The average rate of interest on any mortgage is difficult to calculate if only because there are so many different mortgage products available. Between standard thirty year and twenty percent down mortgages, low down payment mortgages, balloon mortgages, reverse mortgages, and others, it is impossible to determine what the “average” mortgage interest rate will be on your home. That said, it is a safe bet that your mortgage interest rate will currently average somewhere between three and five percent for a conventional or FHA mortgage.
This percentage is the critical factor that should drive your financial decision to mortgage your new home and rent your old home versus simply selling your old home and applying the proceeds from the sale. Risk averse people may always want to apply the sale proceeds directly to the new home because it will consistently generate a three to six percentage return depending on the mortgage that you would have had to acquire. However, you could save money by either renting your old home out or selling your old home and investing the proceeds. If your rental income would net you a larger payment over time, then you should rent your apartment. Similarly, if you can invest the sale proceeds at a higher rate of return (reliably) than the rate of the mortgage interest, it may be worthwhile to allow the percentages to trade off.
Considerations in Renting
If you choose to maintain ownership of two properties and rent out an older property, there are several legal and financial considerations you should take into account. First, financially, you should take steps to ensure that the rental proceeds will outweigh the cost of the mortgage on the new home. If an average mortgage interest rate is three to five percent, you should try to make at least the average return on the mortgage back in rent. In the New York City market, this may not be difficult due to high rental values and a demand for housing. You should also keep in mind the cost of repairs and other financial obligations of landlords (such as payment of property taxes).
From a legal standpoint, you should be aware that becoming a landlord results in a number of legal obligations. The most important of those obligations is the warranty of habitability. Leased premises must be safe for habitation, which means that as a landlord, you will have a legal obligation to undertake necessary repairs. Additionally, you should also be aware of the contractual nature of a rental agreement. A rental agreement is a legally-binding contract between two parties that is enforceable in court. Even so, however, a tenant may leave abruptly or create problems, and even though your contract is supposed to bind the tenant to his or her contractual obligations, actually enforcing those contractual obligations in court could become expensive.
Considerations in Investing
Selling your old home and investing the proceeds while mortgaging your new home also carries with it certain risks. The financial risks should be obvious: investments with returns greater than five percent tend to entail a certain amount of risk, and it may be unwise for an investor to invest such a large sum while taking a mortgage for a few percentage points of return.
There are no strict legal risks involved with investing (although remember that if you default on your mortgage, the bank will foreclose); however, you should make sure to follow all applicable investment regulations. For example, file appropriate statements and avoid insider trading.
Also Consider Market Value over Time
As we explained above, we are attorneys, not financial advisors. We cannot predict market bubbles or determine long-term real investment options. That is the purview of real estate speculators. That said, there may be a better time to sell your current home. Without adjusting for neighborhood to neighborhood marketing trends, if you sell your home and buy a new home at the same time, you are making two transactions during the same market period. There are seller’s markets and there are buyer’s markets, and in an ideal world, you want to sell in a seller’s market and buy in a buyer’s market. If you are in a buyer’s market, you may want to hold onto your current home until a seller’s market occurs (although this obviously can be risky because you never know when home prices could suddenly tilt).
If you are considering the purchase or sale of a home, you should contact a real estate attorney to review your legal options. The Law Office of Yuriy Moshes practices real estate law in New York and New Jersey, and can assist in contract drafting and sale negotiations.