You probably don’t want to deal with a bridge loan, but if you find yourself in a position where you need one, it can be a lifesaver. Bridge loan rates are typically much higher than rates on fixed-rate mortgages, sometimes a full two percent higher, and they come with equally high closing costs and fees. If your situation demands it and you can afford it, a bridge loan might be the best way to buy the home of your dreams when timing on the sale of your existing home is off.
What Is a Bridge Loan?
Bridge loans, which are also known as gap financing, swing loans or interim financing, are short-term loans which are designed to fill the gap when you purchase a new home before your existing one sells. The loan term is generally for a six-month period, though it some lenders will extend it to 12 months.
How Do Bridge Loans Work?
There are two basic types of swing loans, although each one has several variations. In the first scenario, the lender gives you enough financing to completely pay off your existing mortgage and any other liens, allowing you to use any excess toward a down payment. That frees you up to then take on a mortgage for your new home. With this type of loan, you generally won’t have to make any interim payments on the bridge loan as the proceeds from the sale of your home will pay it off in its entirety.
The second type of bridge loan acts as a second (or third) mortgage, and the loan itself is used solely to put a down payment on the new home. In this case, you’ll have to be prepared financially to pay for the mortgage on your old home, the mortgage on your new home and the bridge loan, and that could last for up to one year.
In either one of these scenarios, you might be required to pay a lump sum interest payment either when you take out the loan or when you pay it off. Bridge loan rates can vary widely as well, but they all will typically cost the same. If you’re required to make a large lump sum payment, you might find that your loan is issued at the prime rate. If you’re charged lower fees, you may find that you’re charge prime rate plus up to two percent interest. Most bridge loans share one common characteristic; the lender who issues you the bridge loan requires that you take out the mortgage for your new home with the same financial institution. Depending on what bank you take out the bridge loan with, this may or may not be in your favor.
When Would I Need to Take Out a Bridge Loan?
Some people opt to shop for a new home before selling their existing one, hoping that a bridge loan will make everything work out, but that may cost them big in fees and interest. However, if you have to quickly relocate for your job or due to a family issue, you may need to look into this type of loan despite the high bridge loan rates. Keep in mind that if you’re relocating for your job but staying with the same company, there’s a good chance that the company will pick up the additional costs of a bridge loan for you so that your move isn’t delayed.
Shopping for a new home before your current house sells will give you an idea of what’s available, and you’ll be prepared if your home sells quickly. It’s possible, however, that you find the perfect home for your family and you don’t want to chance losing it while waiting for your current home to sell. Rather than risk a bridge loan scenario, you can proceed with the purchase but put a contingency in your contract that states that if your existing home doesn’t sell in time, you can walk away from the deal. Many buyers won’t accept that type of contingency, and it’s up to you at that point to risk going ahead with the purchase and possibility of a bridge loan or to walk away altogether.
Are Bridge Loans Risky?
If you take out a bridge loan, it was probably (or at least hopefully) your only option. Unfortunately, there is always the risk that your existing home doesn’t sell before the bridge loan comes due. To keep this risk to a minimum, look into the average time on the market for similar homes in the area before you take out any loans.
If your home doesn’t sell by the end of the bridge loan term, you could be in a world of financial hurt. When you’re shopping around for a bridge loan, try to find a lender who is willing to negotiate an extension to the loan if your home doesn’t sell. And if you can find one that generally offers lower rates, lock it in so that you also take out your new mortgage with that lender, as that can often garner you better rates.
What Alternatives Are There to Bridge Loans?
Borrowers who rely on the proceeds from their current home to fund the down payment from the new home don’t have a lot of options, but there are some available. VA loans, for example, don’t require any down payment, and there are also zero-down mortgages and combo mortgages that you might be able to qualify for. The FHA does require at least 3.5 percent down before it will approve a mortgage, but the entire proceeds can come from gifts. In fact, if you plan to put at least 20 percent down on a home, many lenders of conventional fixed-rates loans will allow all of it to come from a gift.
While lenders generally don’t allow down payment money to come from an unsecured loan, you can borrow against your 401(k), insurance or any other asset to fund your down payment.
2 Point Highlight
Shopping for a new home before your current house sells will give you an idea of what’s available, and you’ll be prepared if your home sells quickly.
You probably don’t want to deal with a bridge loan, but if you find yourself in a position where you need one, it can be a lifesaver.
