Bridge Loans Can Help You Drop Home Buying Contingencies
- In a competitive housing market
- Home sellers typically will not agree to contingencies from the buyer
- To solve the buy before you sell quandary
- A bridge loan might be a good solution
Many purchase contracts have contingencies that allow the buyer to agree to the terms only if certain actions occur. For example, a buyer may not have to go through with the purchase of the new home they are in contract for unless they are able to sell their old home first. This gives the home & Mortgage buyer protection in the event no one buys their home, or if nobody is willing to buy the property at the terms they desire.
How Do Bridge Loans Work?
- A bridge loan can be used to pay off the loan(s) on your existing property
- So you can buy a new property without selling your current one
- Or it can act as a second/third mortgage behind your existing loan
- To finance a new home purchase
A bridge loan can be structured so it completely pays off the existing loans on the current property, or as a second loan on top of the existing loans. In the first case, the bridge loan pays off all existing loans, and uses the excess as down payment for the new home. In the latter example, the bridge loan is opened as a second or third mortgage, and is used solely as the down payment for the new property.
If you choose the first option, you likely will not make monthly payments on your bridge loan, but instead you will make mortgage payments on your new home. And once your old house sells, you will use the proceeds to pay off the bridge loan, including the associated interest and remaining balance. If you choose the second option, you will still need to make payments on your old mortgage(s) and the new mortgage attached to your new property, which can stretch even the most well-off homeowner’s budget. So make sure you are able to take on such payments for up to a year if necessary. Most consumers do not use bridge loans because they aren’t necessary during housing booms and hot markets.
For example, if your home goes on the market and sells within a month, it is typically not necessary to take out a bridge loan. But now that things have cooled off, they may become a bit more common as sellers experience more difficulty in unloading their homes.
Bridge Loan Rates Are Typically Quite High
One obvious downside to a bridge loan is the high associated interest rate relative to longer-term financing option but because the loans are only intended to be kept for a short period. As noted, interest rates on bridge loans can be costly, typically a couple percentage points or higher above what you would receive on a traditional home loan. Like a standard mortgage, the interest rate can vary widely depending on all the attributes of the loan and the borrower.
Put simply, the more risk you present to the bridge lender, the higher your rate will be. For example, if you need a very high-LTV loan and you’ve got marginal credit, expect an even higher rate. But if you have got excellent credit and plenty of home equity, and just need a small loan to bridge the gap, the interest rate may not be all that bad. And remember, these loans come with short terms, so the high cost of interest will only affect your pocketbook for a few months to a year or so. Just be mindful of the closing costs associated, which are often also inflated because lenders know you will be fairly desperate to obtain financing.
Bridge Loans Can Be Risky
Be careful when you take out a bridge loans there is no guarantee your existing home will sell in a timely manner pay attention to all the terms of the loan and watch out for prepayment penalties!
Many critics find bridge loans to be risky, as the borrower essentially takes on a new loan with a higher interest rate and no guarantee the old property will sell within the allotted life of the bridge loan. However, borrowers usually do not need to pay interest in remaining months if their home is sold before the term of the bridge loan is complete. But watch out for prepayment penalties that hit you if you pay the loan off too early!
Make sure you do plenty of research before selling your home to see what asking prices are and how long homes are generally listed before they are ultimately sold. The market may be strong enough so that you do not need a bridge loan. But if you do need one, be aware that a home could go unsold for six months, or longer, so negotiate terms that allow for an extension to the bridge loan if necessary. If you think a bridge loan is right for you, try to work out a deal with a single lender that provides both your bridge loan and long-term mortgage. Usually they will give you a better deal, and a safety net as opposed to going with two different banks or lenders.
Also keep in mind that there are other alternatives to a bridge loan such as financing down payments with your 401k, stocks, and other assets. Remember to compare each scenario before signing anything!