It can be nerve-wracking to make an offer on a house knowing that the purchase might fall through if you can’t sell your current home in time. Worse, a seller might overlook your offer in favor of someone who’s got cash in hand.
What Is a Bridge Loan?
A bridge loan is a mortgage designed to act as a financing bridge between your new home and your current home. You use a bridge loan to buy the new property and pay it off when you sell your old house.
“Think of it like an interim loan or a short-term loan to get from one financial goal to the next financial goal,” says Anurag Mehrotra, assistant professor of finance at the Fowler College of Business at San Diego State University.
A bridge loan is secured by the equity in your current home, and the loan term is typically six to 18 months. Bridge loans are generally more expensive than first mortgages and qualifying can be more difficult.
How Do Bridge Loans Work?
If you take out a bridge loan, you use the money you’ve borrowed to buy a new property while you try to sell your existing home. While you’re waiting to find a buyer, you make monthly interest-only payments on the bridge loan. Once you sell the home, you pay off the principal in a lump sum.
Suppose you own a condo worth over $300,000, and your mortgage balance is $150,000. This means you have $150,000 in equity. If you take out a bridge loan for $90,000, you could make a 20% down payment on a new house worth $450,000. You make interest-only payments on the bridge loan until you sell your condo. If you net $300,000, you’d repay the $150,000 mortgage balance and the $90,000 bridge loan and keep the remaining $60,000.
Of course, that’s only if you successfully sell your home within the expected time frame. If you don’t sell by the time the principal is due, the lender might postpone the deadline in exchange for a fee and a higher interest rate, giving you higher monthly payments going forward.
“Typically a bridge loan would have some contingencies to extend the loan, but of course all these contingencies come with a cost,” Mehrotra says.
Another option is to restructure the loan so that you pay down the principal in addition to paying interest in your monthly payments.
Before getting a bridge loan, consider the worst-case scenario and have a plan in case the home doesn’t sell. And it’s important to vet lenders carefully and choose one that’s reputable.
“They should never get into a situation where if they can’t pay it off in 12 to 18 months, the bank says, ‘There are no alternatives, there’s no flexibility, you pay it all off or we foreclose on you.’ That’s not a loan anybody should be taking out,” says Shmuel Shayowitz, president and chief lending officer at Approved Funding.
Bridge Loan Fees and Interest Rates
Interest rates on bridge loans may be a few percentage points above the prime rate. You’ll also owe the usual closing costs including title and escrow charges and lender fees.
Churchill Mortgage, for example, offers a six-month bridge loan with an interest rate of 11.5%, or 3 percentage points above the prime rate. This loan comes with a 2% origination charge.
How to Qualify for a Bridge Loan
Applying for a bridge loan is very similar to applying for a first mortgage. You share information about your identity such as your birthdate and Social Security number. You also submit the details of your income, assets and debts, and the lender checks your credit.
You can expect your finances to be scrutinized closely in underwriting.
“It’s going to be a little more stringent than a traditional mortgage because they want to make sure that you’re not overextending yourself and you can actually make payments on both loans – your existing mortgage and the bridge loan,” Mehrotra says.
You’ll also need to get an appraisal and show that you have sufficient equity in your home, as lenders won’t want your first mortgage balance plus the bridge loan to exceed 80% of your home’s value.
Bridge Loan Pros and Cons
A bridge loan can be helpful if you want to move quickly on buying a specific property, but it costs more than a first mortgage and carries risks.
Pros And Cons Enhancement : Pros and Cons – Buying a Home: How to Use a Bridge Loan
Bridge Loan Alternatives
Due to its risks and associated costs, a bridge loan shouldn’t be your first choice when financing a new home purchase. Here are some alternatives to consider.
Home Equity Loan or Line of Credit
Either a home equity loan or line of credit allows you to borrow against the equity in your current home. Home equity loans have longer terms than bridge loans, giving you more breathing room if you can’t sell your home right away.
A home equity line of credit usually comes with a draw period followed by a repayment period. During the draw period, you might only have to pay interest on what you’ve borrowed, similar to the interest-only requirement of a bridge loan.
“That is definitely something that is common, possible and available, and people should consider that first,” Shayowitz says.
Personal Loan
An unsecured personal loan doesn’t put your home at risk. But rates may be higher than a home equity loan or line of credit.
Hard Money Loan
If you’re buying a home for the purpose of rehabbing it and selling it again, you might choose a hard money loan, which is a short-term loan for real estate investing or house flipping. You borrow against the home you’re flipping, not your residence. Hard money loans require as much as 50% down, their interest rates are even higher than bridge loans and you’ll pay several points in loan fees. Borrowing with hard money increases the risk of a home flip. If you don’t get your price or you don’t sell fast, you could end up losing money on the transaction.
Discounting Your Home’s Sale Price
You could reduce the asking price for your current home to sell it faster and eliminate the need for bridge financing. If the amount of the discount is less than what you would pay for a bridge loan, you come out ahead.
The bridge loan is one way to pull off a new home purchase while selling an old home. But it may not be the best way.
