When selling one home and buying another one, the timing can be tricky. You may not have the money to purchase a new home while you’re still paying for your existing one, but there are times when you may not have a choice. What is a bridge loan? It’s short-term financing offered by lenders to bridge the gap until your home has been sold. Bridge loans, which are also called swing loans, gap financing or interim financing, have a definite set of pros and cons, and it’s in your best interests to learn everything you can about them before you sign a contract.
When Would I Need a Bridge Loan?
You’re always better off waiting until your home sells before you put money down on a new home, but that’s not always possible. There are several circumstances that might force you to take out a bridge loan, including:
- The sale on your house falls through after you’ve put a deposit down on a new home
- A job relocation to another city or state
- Forced move for family or medical reasons
- A home that’s ideal for your situation comes up for sale and yours doesn’t sell quickly enough
How Do Bridge Loans Work?
Perhaps you’ve found a new home that costs $250,000 and your current home hasn’t sold yet. You have $100,000 of equity in existing home, which is enough to cover the 20 percent down payment you plan to make, but you don’t have enough cash in the bank to cover that $50,000 down payment. A bridge loan would give you the short-term funding you need to cover that down payment until your home is sold. These loans aren’t forever. The average length of time you have to repay a bridge loan is between six months to one year.
Bridge loans can be structured one of two ways. In the first scenario, the bridge loan pays off all of your current home’s liens, and the excess goes toward the down payment of your new home. With this type of structure, you probably won’t be required to make monthly payments on the bridge loan itself, but you will have to make the monthly payments on your new home’s loan. It’s likely that the lender will charge you hefty upfront fees or a lump sum interest payment at the end of the loan.
In the second scenario, the bridge loan works very much like a second mortgage. In this case, you’ll have to be able to handle the mortgage payments on your existing home as well as your new home until it sells.
What Do I Need to Qualify for a Bridge Loan?
Like any other loan, you’ll need to have a good credit score and financial history in order to qualify for a bridge loan. Many financial institutions allow bridge loans of up to 80 percent of the equity you have in your home, but some lenders only allow up to 80 percent of the home’s market value less the remaining principal on the mortgage. If you only have $50,000 equity in your current home, you’ll only likely qualify for a bridge loan of up to $40,000. A common requirement when seeking bridge financing is that you must commit to taking out the permanent mortgage for your new home with the lender that is giving you the bridge loan.
The guidelines to qualify for a bridge loan are rather fuzzy, and most lenders don’t have set limits for credit scores or debt-to-income ratios. Rather, they look at each individual situation and make judgments accordingly.
How Much do Bridge Loans Cost?
Lenders know that borrowers only seek out bridge loans when they’re out of other options, and they make them pay for the privilege. Rates and fees vary depending on the lender and the geographic location of the home, but interest rates are normally two percent higher than the going rate. There are also a variety of fees and other costs associated with the loan, including administration, appraisal, escrow, title policy, notary and recording fees. You’ll also be assessed points on the loan based on the amount of money you’re looking to borrow. In California, for example, the average fees are roughly $25,000 and points can cost up to $2,500 or more.
Is a Bridge Loan the Best Option?
Having access to a bridge loan gives you the freedom to buy the house you want instead of settling for a house that’s available when you need it. However, bridge loans are more expensive than almost any other option, including home equity loans or a home equity line of credit (HELOC), which would cost you less than $500. The problem with a HELOC is that many financial institutions won’t approve it if your current home is listed for sale. They see this as a short-term loan that won’t be very profitable for them.
As you shop around for mortgages for that new home, however, you need to be very careful about where the down payment money comes from, as lenders are very strict in this regard. They generally will not allow you to make a down payment with money from an unsecured loan, but they will accept secured loans such as bridge loans or loans on your 401K, stocks and bonds, insurance policy or other asset. Lenders also allows gifts from family members, although they may make you jump through hoops when you try it.
2 Point Highlight
Like any other loan, you’ll need to have a good credit score and financial history in order to qualify for a bridge loan.
Having access to a bridge loan gives you the freedom to buy the house you want instead of settling for a house that’s available when you need it.
