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6 Pros and Cons of Bridge Loans and How They Work

The timing can be tricky between selling your current home and buying your new one. And as it goes, rarely do the stars align in your favor. To help you cover the financial gap between selling your old home and buying your new one, a bridge loan may be right for you.
The timing can be tricky between selling your current home and buying your new one. And as it goes, rarely do the stars align in your favor. To help you cover the financial gap between selling your old home and buying your new one, a bridge loan may be right for you.

Typically when buying a new home, you need to sell your current home first and use the proceeds as a down payment for your new home. Unfortunately, the home buying process isn’t always so black and white.

What happens if your dream home goes on the market before you’ve sold your current home? What if the proceeds from your home sale don’t cover the entire down payment on your new home? This is when many turn to the bridge loan.

What is a bridge loan and how does it work?

A bridge loan is a short term loan that lets you access your current home’s equity before your home is even sold, allowing you the time to shop around for a new house and put a down payment on a home without worrying about selling your old home first.

Aptly named, a bridge loan bridges the gap between your old mortgage and your new one. For instance, typically, you’d take out a bridge loan to pay off what’s left of your old mortgage and use whatever is left towards closing costs and a down payment on your new home.

Then, once your old home sells, you use those proceeds to pay off the bridge loan with the rest going towards your new mortgage. It seems pretty slick, but, this entire operation depends on if your old home sells and sells for a high enough price to cover your bridge loan payments.

While bridge loans can help buyers who need to snatch up a home quickly or who don’t have enough cash for a down payment, these loans don’t come without a bit of risk. So, does a bridge loan make sense for you? Here are a few pros and cons to help you discover what’s best for you.

Pros

You’re More Attractive to Sellers

There’s nothing like a good old-fashioned bidding war to put excessive stress on the already stressful home buying process. When you’re battling to win a home that’s received multiple buyer offers, a bridge loan can put you in the lead because your offer won’t have a sales contingency.

Many potential buyers have a sale contingency in their offer which means if their current home doesn’t sell, they’re able to back out of the sale. Understandably, this can make sellers nervous.

But, with a bridge loan, you already have guaranteed funds to buy the home making the sale almost certain, giving you the advantage over other buyers.

Flexibility When Buying and Selling

One of the biggest perks of a bridge loan is that you can finance a new home before your old one sells — you don’t have to wait on the sales proceeds from your current home giving you more freedom and flexibility when shopping around for a new home.

This means you won’t miss out on your dream home. So when that three-bedroom home with the deck and brand new kitchen finally goes on the market, you won’t have to wait. With a bridge loan, you can make an offer immediately before it gets snatched up and not worry about covering two mortgages.

You May Not Have Payments for a Few Months

While you’ll want to discuss the terms of your bridge loan thoroughly as each lender structures these loans a little differently, generally, you won’t have to start making immediate payments on your loan. You’ll get a bit of breathing space before you’re on the hook for any payments.

Bridge loans are short term lasting only about six months to a year. Some lenders won’t require you to make payments for four or six months or will wait until your old home sells so you have the funds to start paying off the loan.

Cons

You Increase Your Total Debt

Not only will you have your old mortgage, but you’re also on the hook for your new mortgage plus the bridge loan. This can turn into a disastrous situation if your old home doesn’t sell, or doesn’t sell for a price that will cover your other debts.

If this happens, you’re left with two mortgages and a loan without the funds to pay with, putting you even further in debt. Also, keep in mind that once you apply to refinance from the bridge loan to a long-term loan, there’s no guarantee you’ll be approved for refinancing.

To avoid these scenarios, make sure you’re the optimal candidate with stellar credit, sufficient income, and a small emergency fund if all hell breaks loose.

They’re More Risky

Bridge loans are inherently more risky than a normal long-term loan. Once you take out a bridge loan the clock starts ticking on the window to sell your home. Because bridge loans only last for six months or a year, you need to be positive your home will sell within that timeframe so you have the proceeds to pay off the loan.

Even if you have a buyer lined up, there’s a possibility they could back out of the sale at the last minute due to their own sales contingency or if their financing falls through.

You’re also at the mercy of the housing market conditions. If the market swings to favor buyers, you may have more trouble selling your home for a high enough price, or at all.

High Interest Rates

With high risk comes a high price. Literally. Because bridge loans carry more risk and are short-term, lenders protect themselves by charging high interest rates that can run anywhere from 8.5% to 10.5% of the total loan.

Your lender may even use a variable prime rate that increases over time. And the longer your bridge loan the more interest you’ll owe, putting a strain on your monthly budget. Plus, you’ll also want to factor in additional costs such as appraisals, closing costs, and origination fees.

Work with a Clever Partner Agent for a Smooth Transition

Whether or not you decide a bridge loan is right for you, you’ll want to work with an experienced real estate agent who can help you with the transition between selling your current home and buying your new one.

With a Clever Partner Agent, you’ll work with a top-rated, knowledgeable agent who can help you find a new home for a great price that you’ll be able to afford by using the proceeds from your current home’s sale or a bridge loan.

Your Partner Agent knows your market well and will provide advice and guidance on whether your old home will sell quickly and within the timeframe of your bridge loan making sure you won’t be stuck with two mortgages plus loan payments.

And Clever can help you save even more. You may be eligible for our Home Buyer Rebate program where you’ll receive $1,000 on homes over $150,000 that you can put towards closing or moving costs. Get in touch with Clever to connect to an experienced Partner Agent.

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Reuven Shechter

Reuven Shechter is the Outreach Coordinator at Clever Real Estate, the free online service that connects you with top real estate agents to help save on commission. He spreads the word about Clever, disseminating studies to journalists and developing relationships with media outlets. Reuven is passionate about investing in real estate and creating lasting success for families. His writing has been featured in Max Real Estate Exposure, Leverage Marketing, and more.

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