Moving from one home to another sounds simple in theory. Sell your home, then use the funds from the sale to purchase your new home. However, timing isn’t always on your side in this type of transaction.
What if you find the perfect home but haven’t sold your current home yet? How will you get the money you need? This is the exact scenario where a bridge loan might come in handy.
What is a bridge loan?
In the simplest terms, a bridge loan is a short-term home loan used to bridge the time between purchasing your new home and selling your old home. In practice, things get a little more complicated.
This guide will go over different types of bridge loans and talk about some of the pros and cons of this financial tool.
How does a bridge loan work?
In addition to its uses in real estate, bridge loans can also be used by businesses while they wait for more long-term financing options. However, since this use involves different circumstances, this guide will focus on a bridge loan as it pertains to real estate and better mortgage.
All bridge loans and bridge financing in real estate have a few things in common:
Short term – Most bridge loans don’t last for more than a year so they can be considered a short term loan. Unlike a long term loan, the terms for this short term financing generally apply during a period of around 6-12 months.
Approval odds – Since bridge loans are meant to bridge time while you finish selling your old home, your approval will be secured based on the value of your old or existing home and the equity you have. However, borrowers still need to meet other criteria on their loan application such as good credit and good debt-to-income (DTI) ratio before a lender will approve you for a bridge loan.
A good rule of thumb: If you’re likely to be approved for a new mortgage, it’s a sign you may be a good candidate for a bridge loan. You can better determine your eligibility by assessing how much you can afford when considering a new home.
Fees – The speed of bridge loan approval sometimes comes at a cost. Bridge loans will often have higher origination fees than other traditional or conventional loan options.
Speed – Since bridge loans are designed to be used by buyers who need the money relatively soon, the application and approval phases are set up to be efficient, so that you get access to the money as quickly as possible.
Interest – Again, since these are loans that are meant to be short-term, bridge loan rates will likely be higher than others among more long term loan options.
When would you need a bridge loan?
Bridge loans aren’t always appropriate for people purchasing a new home. In fact, their popularity has fallen quite significantly since the housing crisis of the late 2000s.
That said, there are still several instances in which bridge loans can be useful tools:
When there’s high competition in purchasing a property you’re interested in. The fast access to money that a bridge loan affords you may improve your chances when competing with other prospective buyers.
A bridge loan can help you eliminate contingencies. Some sellers may not want to deal with buyers whose purchasing power is contingent upon the sale of their existing home. By eliminating this factor, you may become a more desirable bidder. If you’re asking yourself, “what is a contingency sale?“, we’ve got you covered!
If you can’t afford the down payment on your new home or if you’re trying to avoid having to purchase private mortgage insurance.
If you’ve already sold your old home but the closing dates would still leave you with a gap you need to fill.
If you’re interested in purchasing before you’ve even started the process of selling your old home. Whatever the reason you’re getting a head start on buying, bridge loans would allow you to buy now and sell later.
Navigating the terms of bridge loans
Within the world of real estate, there isn’t much variation when it comes to bridge loans. Most are applied for and used in a similar way across the board. However, terms may vary from lender to lender so you’ll want to be on the lookout for the best terms possible.
Some of the terms worth considering include:
Interest rate – The interest rate you can secure for your bridge loan will depend on how much equity you have in your current house and your overall creditworthiness. On the low end, your rate may be the same as the prime rate (currently 3.5%). On the higher end, rates will greatly exceed the prime rate, soaring up into double-digit percentages.
Payment – Not all bridge loans will set up payment the same way and not all bridge loans will be paid off in a similar way to other, more traditional loans. Your lender may require monthly payments, want a lump sum payment of interest at the end of the term, or require that the lump sum be taken out of the loan at closing. Furthermore, you may be able to defer payments until the sale of your old home.
Loan term – While bridge loans are short-term, just how short-term they are will be up to you and your lender. Longer-term loans can give you more time to sell your home before the loan comes due. Shorter-term options will likely keep the amount of interest you accrue on the loan to a minimum.
Amount of loan – How much of a loan you’re able to take out will typically depend on your lender and your creditworthiness. The standard maximum amount you’ll likely get for a bridge loan is 80 percent of the combined value of your current home and the home you are planning to purchase.
Risks of bridge loans
Buying a new home can often be a very emotional purchase. When you add in the speed that’s sometimes needed to secure the home you want, you’re liable to allow those emotions to take the place of a more logical, reasoned approach to borrowing.
While bridge loans are an appealing option for you if you need money fast, there are still risks that are worth considering before you decide if a bridge loan is right for your financial situation:
Worth – Remember those fees mentioned earlier? While many loans will come with origination and closing fees, the higher fees you pay on a bridge loan eat into the actual worth of the loan you’re getting. Other financial instruments may let you use the equity you’ve built in your current home to get access to cash at a lesser fee than a bridge loan.
Lack of sale – This is one of the most significant risks associated with bridge loans. Let’s say you have a buyer all lined up for your current home, so you take out a bridge loan for a new home. Then your buyer, for whatever reason, falls through. Now you’re left paying two mortgages—and you’ll need to start paying off your bridge loan.
That puts you in a tough spot—one that could get even tougher if you can’t find a new buyer before your bridge loan comes due.
Leverage – Related to the last point, whenever you put on a clock on yourself, you risk losing leverage. If you have time, you can wait until you get an offer on your old home that you can be happy with. If you don’t have time, you may be forced to take something below market value because you have bills set to come due.
To put yourself in the best position when selling a home, working with a real estate agent is advisable. Their expertise can help ensure you get the most value possible for your home.
Buyer’s market – One time you may want to think twice about utilizing a bridge loan is if you’re in a buyer’s market. In this type of market, you may have more trouble selling your old home. You may also have more leverage (and be able to wait longer) when purchasing your new home.
As with selling, there are many compelling reasons to work with a real estate agent when buying so that you can be sure of your situation and not make any rash decisions.
Difficulty qualifying – Another reason you may avoid taking out a bridge loan is simply because you have no choice in the matter. If you don’t have enough equity in your current home, you likely won’t be approved for a bridge loan. The same goes if you have low credit or a high DTI. Some banks will only consider you for a bridge loan if you also take out your mortgage with them.
Other options to consider
Understanding the risks involved with a bridge loan is a good place to start. However, if you end up deciding that it’s not a fit for you and your situation, you’ll want to be aware of your other options. It is also important to understand what amortization in real estate is and how it could play a pivotal role in your next house purchase. Acceleration clause real estate is also an essential principle to understand.
Let’s take a look at some other ways to access the money you’ve accrued in your current home.
Home equity loan
A home equity loan is just what it sounds like. It’s a loan in which the collateral you use to secure the loan is the equity you’ve accrued in your home. You’re typically given a lump sum and are free to pay it off like you would a normal loan.
Some advantages of a home equity loan include:
Potential for a fixed interest rate.
You may be able to negotiate terms based on the exact amount you need. If that amount is low, you may be able to secure favorable terms.
Upon selling your house, you can pay off the loan. However, if you’d prefer to extend your loan payment, that option may also be available to you.
However, there are a few disadvantages to home equity loans as well:
There may be high fees associated with this type of loan.
Some lenders may require you to pay part of the interest upfront, negating much of the interest savings. They may also limit your ability to pay off the loan early to avoid interest.
If you fail to sell your old house, you now have two mortgages and a loan, the same as you would with a bridge loan.
You still may not qualify if you haven’t built enough equity in your home.
A similar option to the home equity loan is a home equity line of credit, or HELOC. The main difference is that while the home equity loan results in a lump sum, a HELOC gives you access to a line of credit that’s secured by the equity you have in your home.
In this case, you can take out only what you need so you’re not paying interest on the money you don’t need to use.
Some advantages of HELOCs include:
Not all HELOCs have the same fees. Sometimes HELOCs may have no fees at all.
Only taking out what you need protects you from overdrawing and having to pay fees on funds that you didn’t need in the first place.
Interest may be fixed or variable depending on the terms, which could help you in the long run.
HELOCs are split into two phases. In the draw phase, you take out the money you need and make only minimal payments. In repayment, you pay off what you borrowed but are unable to access more money.
HELOCs do come with their own considerations though:
If you have variable rates and the rates go up over time, you may end up paying more than you initially expected.
If unexpected expenses come up during repayment, you may not have access to any more money through your HELOC.
Again, without sufficient equity, you may be unlikely to qualify for a HELOC. Furthermore, some lenders will not even consider granting a HELOC if your home is on the market.
Berkshire Hathaway: buying and selling made simple
Buying and selling homes can be an intricate process. Bridge loans are one financial instrument to consider that may help you on your home buying journey. Even so, it can be hard to know what the best option is for your unique scenario. That’s why it’s worth consulting the experts.
At Berkshire Hathaway HomeServices California Properties we have experts ready to help you. Working with a qualified real estate agent will allow you navigate the market with finesse. They’ll ensure you get the best deal on your new home and the best return on your old home.
When you’re ready to start your journey, we’re ready to help.