There’s a certain kind of panic that runs down the back of your neck and makes its home in your belly when you think about selling your home without closing on a new one first. Just thinking about couch surfing from house to house on the good will of friends and family to having to pack everything multiple times is enough to make the calmest person frantic. Beyond that, you may even end up needing to settle for a house that is not much better than the one you currently own just to have a place to live.
Or you could use a bridge loan.
What are bridge loans?
A bridge loan is a short-term loan that an individual (or company) uses until they can get secure long-term financing to pay back the bridge loan. In real estate, a home buyer may get a bridge loan to help them in buying a new home before selling their existing home.
How do bridge loans work?
Bridge loans are also known as interim financing. They are usually issued by your bank or local lender. Acquiring a bridge loan is a short process compared to other loans.
Typically, once you have been approved for a bridge loan, you’ll use that money to pay for your new home and bridge the gap until you sell your current home. Once you sell your current home, you will use that money to pay off the bridge loan and any loan fees associated with the interim financing.
You may be required to pay monthly payments on your bridge loan, or you may not have any payments for the first few months but still accumulate interest during that time. You’ll want to talk with your lender to see how they’ll structure it.
The length of a bridge loan depends on how long you’ll need it for. It could last only a few months or even up to a year.
Bridge Loan Example
You are planning on buying a house worth $350,000 and selling your house, which is currently worth $175,000. You haven’t listed your home for sale yet because you want to make sure you have a place to live while closing on your new house.
So, you go to your mortgage lender and get approved for a bridge loan worth $120,000. That covers the closing costs and the down payment for your new house. You sell your home for $175,000, pay off the bridge loan plus the origination fee and other fees, and pocket the remaining money.
Keep in mind that because the loan is shorter than traditional loans, you’ll have higher interest rates so the bank makes money.
Benefits of Bridge Loans
There are several aspects of bridge loans that make them very appealing to buyers.
Peace of Mind
Bridge loans allow you the peace of mind of being able to stay in your current home while closing on your new home. Because things often go wrong in the home buying process, this reassurance is worth a lot.
More Attractive Offer
Bridge loans also allow you to purchase your new home without restrictions like contingencies. Buying without contingencies makes your offer more attractive to the seller and can be the difference between getting your dream house or not.
No Monthly Payments (Hopefully!)
Depending on how your bridge loan is set up, you may not have to make payments on it for several months. Talk about the best of both worlds!
Drawbacks of Bridge Loans
There are drawbacks to bridge loans depending on your situation.
Difficult Application Process
The loan process itself might be short, but getting approved for a bridge loan is no easy feat. You must have an excellent credit score and debt to income ratio. Because bridge loans gone wrong have been known to cause financial stress, your lender will have to see that you can afford both mortgage payments at the same time.
As previously mentioned, there have been instances where sellers can’t sell their house and are stuck paying two mortgages while they figure out how to pay back the bridge loan.
You will be taking on a pretty hefty amount of risk when you agree to a bridge loan. You are betting that you will be able to sell your house before your bridge loan comes due—which isn’t always within your power to control.
Hard to Find
Since the housing market crash of 2009, lenders are being very careful approving people for bridge loans. If your credit needs work or your finances are pretty tight as it is, you might as well kiss your opportunity of getting a bridge loan goodbye.
Alternatives to Bridge Loans
You might have been hoping to bridge the gap with interim financing only to have your hopes shattered. Luckily, there are alternatives to getting a bridge loan.
Home Equity Line of Credit
If you are considering a bridge loan, then you already own a home. Why not take out an equity line of credit against the house? Monthly payments and interest is usually much lower for a line of credit than a bridge loan anyway. You’ll also have the same chance of paying it off when you sell as you would with a bridge loan.
This alternative isn’t nearly as easy to execute depending on the housing market, but it is an option. If you are in a buyer’s market, you may be able to make an offer on a house contingent upon the sale of your home. That way, the seller can continue to market the house until you either sell yours or they receive a better offer.
Contingencies make your offer less attractive, though, so be careful going this route.
Fees for Bridge Loans
There are several fees that you’ll need to be aware of when you take out a bridge loan. Remember, the fees will be different based on the amount you take out for the loan. Here is an example of a $10,000 bridge loan, thanks to Credit Sesame.
- Amount of Loan: $10,000
- Interest Rate: 8.5%
- Terms: No payments for four months, interest accrues throughout life of the loan and is due upon the sale of the original house.
- Administration fees: $850
- Appraisal fee: $475
- Escrow fee: $450
- Title: $450+
- Notary fees: $40
- Wiring fees: $75
- Loan origination fee: 1%+ of the loan amount
Many of these fees are similar to traditional loans, but a traditional loan typically has a lower interest rate and different terms.
So, how about it? Do you think a bridge loan is right for you? If so, talk to your mortgage lender about your options today.
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