"Trading a Home to the Builder or Seller: How Much of the Down Payment Does the Trade Cover?"

Usually most of it, and on a one-unit primary home often all of it. Fannie Mae, Freddie Mac and FHA all accept a home you trade in as funds to close, and all three start from the same figure: the lesser of the appraised value or the trade-in price both sides agreed to. What each one subtracts after that is different, and the difference can be thousands of dollars.

I'm Jeff Moran, a mortgage broker in Bluffton, South Carolina, originating since 1996, licensed in fifteen states, NMLS #483943, through C2 Financial Corporation.

A builder with a sales office and unsold inventory will sometimes offer to take your current home in on the purchase of a new one. A private seller moving the other direction will occasionally do the same thing. It solves a real problem for you, because it removes the sale that would otherwise have to happen before you can move. It also changes what your lender is looking at, and that change is worth understanding before you sign a worksheet.

What is trade equity, and when does it come up?

Trade equity is what the agencies call it when a property changes hands as part of the payment for another property. You hand over a home you already own, the builder or the seller takes it in, and the value of what you handed over gets credited toward the purchase of the new one. Fannie Mae's rule is B3-4.3-11, Trade Equity in the Selling Guide, revised 12/16/2020 under Announcement SEL-2020-07.

It shows up most often on new construction, where a builder has a finished home ready and a buyer who cannot move until the current one sells. It also shows up between two private parties who each want what the other has.

This is a different arrangement from the two more familiar ones. Selling first and then buying turns your departing home into cash on the open market and puts the sequencing question at the center of everything. Borrowing against the departing home to buy before you sell keeps the property and adds a lien to it. In a trade the property leaves, no cash ever moves, and that is most of the appeal.

Trade equity goes on your loan application as a credit to the transaction, which reduces the funds you need to close. It is not treated as a deposit arriving in a bank account, so none of the sourcing questions a large deposit raises apply to it.

How is the equity contribution calculated?

All three rulebooks start at the same place, and then they subtract slightly different things.

Rulebook	Start from	Subtract
Fannie Mae, B3-4.3-11	the lesser of the appraised value or the trade-in value both parties agreed to	the outstanding mortgage balance, plus any transfer costs
Freddie Mac, Section 5501.3(f)	the lesser of the appraised value or the trade-in price shown in the trade-in contract	any outstanding liens, plus any transfer costs
FHA, Handbook 4000.1 II.A.4.d	the lesser of the appraised value or the sales price	all liens against the property being traded, along with any real estate commission

Two differences in that table change your number.

Fannie Mae subtracts the outstanding mortgage balance. Freddie Mac and FHA subtract liens, and a lien is a wider category than a mortgage. A second mortgage, a home equity line you never closed out, a contractor's lien or a recorded judgment all come off the top under those two, so if you planned around the first-mortgage payoff alone you will be short.

FHA names the real estate commission specifically, and neither of the other two does. On a trade where a listing agent is still being paid, that is a line worth pricing before anybody promises you a number.

Every one of the three starts at the appraised value of the property you are handing over. Your trade is worth what an appraiser says it is worth, capped by whatever the two sides agreed to. A generous number on a builder's worksheet does not become a generous credit in your file, and what happens when an appraisal lands under the contract price is the same conversation here, on the other side of the transaction.

Do you still have to put in money of your own?

On a conventional loan, Fannie Mae allows trade equity to supplement the minimum contribution it requires from your own funds. That minimum has to be met first, unless one of two conditions is true.

The first is a loan-to-value and combined loan-to-value of 80 percent or lower. The second is a one-unit primary home where you meet the conditions for using gift, grant or employer money toward that minimum.

That second condition covers most purchases. Fannie Mae's table in B3-4.3-04, Personal Gifts asks for no minimum from your own funds on a one-unit primary home, at any loan-to-value. So on a single-family home you intend to live in, the trade can carry the down payment on its own.

Where it genuinely changes something is a two- to four-unit primary home or a second home above 80 percent loan-to-value. There, 5 percent of the purchase has to come from your own money, and the trade equity goes on top of that 5 percent rather than in place of it. If you are trading into a duplex, you'll want that figure identified early, because it is real cash on a transaction you set up to avoid needing any.

What if the trade runs on two contracts instead of one?

It is still a trade, and Fannie Mae says so directly. The requirements apply to every transaction involving a property trade, including one written as two separate contracts with the buyer and the seller reversing roles on the second.

That matters because two contracts is how these are often papered. The builder buys your current home on one contract, you buy the new home on another, and both close the same day. It can look like two ordinary sales side by side. Underwriting reads it as one trade, which means the calculation above and the documentation below both apply.

What does your lender need in the file?

Each agency asks for a different set, and the Fannie Mae list is the longest.

Fannie Mae wants the transfer deed recorded, and a search of the land records to verify who owns the property and whether anything is recorded against it. It also wants proof that title transferred, and proof that any existing mortgage liens you were liable for were satisfied.

Freddie Mac wants two items: the appraisal of the previously owned residence, and the trade-in contract.

FHA wants a residential appraisal report that complies with FHA appraisal policy, and the Closing Disclosure or a similar legal document showing the sale of the property.

FHA adds one condition the other two do not. If the home you are trading carries an FHA-insured mortgage, assumption processing requirements and restrictions apply to it. That is a separate piece of work with its own timeline.

When you're ready, please provide the trade-in contract or the purchase agreement covering the home you are trading, all pages, please. We will also need the most recent mortgage statement for that property, plus a payoff figure, and a written list of anything else recorded against it.

Where a trade gets stuck

Pricing the trade off the builder's worksheet. The worksheet is a sales document, but the credit gets built on the appraisal, and the gap between the two belongs in your plan from the start.

Counting only the first mortgage. Under Freddie Mac and FHA every lien against the property you are trading comes out of the equity. Please ask the title company for a search on that property early, at the same time everyone is looking at the new one.

Assuming the trade solves the down payment on a two- to four-unit. It does not on a conventional loan above 80 percent loan-to-value. The 5 percent minimum from your own funds comes first, and the trade equity supplements it.

Treating it like a gift of equity. These are two different things with two different rules. A gift of equity is a relative selling below value on one property. A trade is two properties valued against each other, and the paperwork for one does not answer the questions asked about the other.

Leaving the FHA loan on the traded home unexamined. If that home carries FHA financing, somebody has to work through the assumption requirements, and that is better known before your offer than after.

An illustration, so the shape is clear

Numbers below are made up to show the mechanism. They are not a quote and not anyone's transaction.

Say a builder agrees to take your current home at a trade-in value of $355,000. The appraisal on that home comes back at $340,000. Your mortgage payoff is $212,000, there is a $24,000 home equity line still open on it, and transfer costs run $9,000.

Agreed trade-in value                $355,000
Appraised value                      $340,000
The lesser of the two                $340,000

Fannie Mae
  less the mortgage payoff          -$212,000
  less transfer costs                 -$9,000
                                    ---------
  trade equity credited              $119,000

Freddie Mac
  less the mortgage payoff          -$212,000
  less the home equity line          -$24,000
  less transfer costs                 -$9,000
                                    ---------
  trade equity credited               $95,000

The same home and the same trade come out $24,000 apart depending on which rulebook your loan follows. The $15,000 the builder wrote above the appraisal never reaches the file under either one. If the new home is a one-unit primary residence, either figure can carry the down payment with nothing required from your savings. On a duplex above 80 percent loan-to-value, 5 percent of the purchase still has to come from your own account.

Common questions

Does trade equity count as my own funds?

On a conventional loan, Fannie Mae treats it as a source that supplements the minimum contribution from your own funds rather than as those funds themselves. That distinction only bites where a minimum contribution is required, which is a two- to four-unit primary home or a second home above 80 percent loan-to-value. On a one-unit primary home Fannie Mae asks for no minimum from your own funds at any loan-to-value, so the question stops mattering there. Freddie Mac lists trade equity under proceeds from the sale of real estate and other assets in Section 5501.3, which is its section on personal funds.

Does the home I am trading have to be appraised?

Yes, under all three rulebooks. Fannie Mae requires the value credited for the home you are trading to be supported by a current appraisal rather than by the figure the two sides agreed to. Freddie Mac names the appraisal of the previously owned residence as required documentation. FHA requires a residential appraisal report complying with FHA appraisal policy. The appraisal is also the ceiling on your credit, because every formula starts from the lesser of the appraised value and the agreed price.

What if my home is worth more than the builder agreed to pay for it?

Then the agreed price is the number the calculation starts from, because each formula takes the lesser of the two. An appraisal above the trade-in price does not raise your credit. It is still worth having early, since it tells you what you are giving up by trading rather than listing, and that comparison is easier to make before a contract than after one.

Can trade equity cover my whole down payment?

On a one-unit primary home financed conventionally, it can, since Fannie Mae asks for no minimum contribution from your own funds there at any loan-to-value. Nothing in the rule stops it. The only question is whether the equity left after your payoff, the liens and the transfer costs is enough to cover the down payment the new purchase needs. Closing costs and reserves are separate questions on top of it, and what an underwriter counts as reserves is worth settling in the same conversation.

What happens if the home I am trading still has an FHA loan on it?

FHA's rule says assumption processing requirements and restrictions apply when the property being traded carries an FHA-insured mortgage. The practical effect is an extra approval running alongside your purchase, on somebody else's timeline. Please raise it at application rather than at contract, so the schedule gets built around it.

Is a trade the same thing as a builder buyout or a relocation buyout?

No. In a buyout, a third party or an employer purchases your home outright and you receive proceeds, which your file then documents as proceeds from a sale. In a trade, no money changes hands, and the home you hand over is what pays for the new one. Freddie Mac lists the two separately in Section 5501.3 for that reason, and the documentation each one calls for is different.

What to do now

The two figures that decide a trade are the appraised value of the home you are handing over and everything recorded against it. You can establish both well before a contract, and both are cheaper to find out early.

With a payoff figure and a lien search in hand, you can see rates and closing costs for the new purchase and put the payment, the cash to close and the debt ratio side by side. That runs without a credit pull and without an account. Choose the option that works best for you, and the selection can change later.

From there the useful step is getting properly pre-approved with the documents in front of somebody, with the trade described in your file from the start. On a new-construction trade it also pays to read how a builder's preferred lender fits alongside an outside one before the incentive conversation starts.