Real estate trades happen more frequently than you realize. I predict they will increase as a percentage of the total number of transactions over the next few years. There are two forces that will fuel their popularity. The first is a general tightening of mortgage underwriting guidelines. The other push will come from the downsizing of the baby boomers. Someday soon a lot of sellers are going to be headed against the normal flow of real estate. As the number of downsizers out number the upwardly mobile, SMACK! It is going to cause some ripples.
People will find a way to accomplish their own goal regardless of what pressures squeeze the real estate market. Trading properties is only one of the tools that will be utilized to compensate for tight market conditions. Keep in mind that this is nothing new. Every sale is actually a trade. Exchanging money for anything is a trade. Cash has become an easy medium for us to understand because of its universal acceptance and its ease of accountability for the bookkeepers of the world.
That hasn't always been the case. There was a time when barter was more common than cash transactions. I doubt it will ever be more acceptable than cash in the future but it can still solve problems.
Trading real estate is not complicated; it is just different than using cash as a medium. Will it work in every situation like cash? No, of course not, it requires that both parties want each other's property. Allow me to rephrase that, both parties must want the other party's property more than they want their existing property.
Let's look at how it works. Assume that Tom owns a home worth $200,000, and Sue lives on the other side of town in a similar house also worth $200,000. If both homes are free and clear, no mortgages on either property, then all that needs to happen is Tom deeds his home to Sue and she deeds her home to Tom. If you look closely, it is almost like Tom bought Sue's home and she bought his. But that is not what technically happened, they traded properties, it was a simultaneous closing.
What if Tom owes $50,000 on his existing home? At the closing Tom must deed his property to Sue free and clear because her home is free and clear. He accomplishes this by placing a $50,000 loan on the home he is trading for and then pays off his old mortgage.
Now that we understand the basics let me tell you when it comes to real estate, nothing is as simple as the two examples above. Tom's home could be worth $175,000 and he still owes $50,000, and Sue's home is still free and clear and worth $200,000. There is a trick I use that keeps the math extremely simple. Remember Ben Franklin's "T" bar method of making a decision? Old Ben would place plus items on one side of the bar and negative items on the other and the longest list won.
Draw a "T" on a piece of paper. Above the cap of the T on the left side write Tom, and of course Sue goes on the right side. Next we enter the values of the homes each party owns before they trade, under the cap of the T. So below Tom's name we enter $175,000 and $200,000 goes under Sue's name. I like the T-bar because it makes it very easy to see both positions side-by-side. In a trade, the equities on both sides must balance so if Tom did not have a mortgage on his existing home, he would owe Sue $25,000. What we are doing is balancing equities with this tool. But let's get back to our example; Tom owes $50,000 against his $175,000 home. On his side of the bar we place his mortgage amount right under his value, next we subtract it from the value leaving an equity on his side of $125,000. Sue did not have a mortgage so she gets a zero in her mortgage position; $200,000 minus zero equals $200,000 on her side for equity. It is easy to see that Tom would owe Sue $75,000 when they trade. This simple little tool will balance equities no matter how many properties or parties are involved.
I have already mentioned why people trade properties. The reason is always the same; each party wants what the other party has more than they want what they already have. Wait a minute, isn't that the same motivation behind people selling a home and buying another one? Exactly the same. Trading is simply another method of moving from one property to another.
Are their any benefits to trading versus selling and then buying? The biggest advantage is having a built in buyer for your existing home, you eliminate one step. There are actually many other benefits when it is the right fit and the better the fit the fewer the parties are needed. If both properties are free and clear for example, no one second guesses the values, no appraisals, no bankers, mortgage companies, etc.
I think the biggest advantage is in a trade is there is no buyer or seller, both parties are in the same mode, simply moving on.
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