Buying a new home before you can sell your old one can present quite the financial conundrum. This is mostly because you have to come up with the cash for a new property when you don’t have access to the home equity you have already built up in your existing property. That’s where a bridge loan comes in.
What is a bridge loan?
Bridge loans promise to fill the gap or “provide a bridge” between your old residence and the one you hope to buy. They accomplish this by providing temporary financial assistance through short-term lending.
Unfortunately, bridge loans come with pitfalls, some of which can be costly or have long-term financial consequences. This guide will explain the good and the bad about bridge loans, how they work, and some alternative strategies.
How does a bridge loan work?
While bridge loans can come in different amounts and last for varying lengths of time, they are meant to be short-term tools. Generally speaking, bridge loans are temporary financing options intended to help real estate buyers secure initial funding that helps them transition from one property to the next.
Let’s say you found your dream home and need to buy it quickly, yet you haven’t had the time to prepare your current residence for sale, let alone sell it. A bridge loan would provide the short-term funding required to purchase the new home quickly, buying you time to get your current home ready for sale. Ideally, you would move into your new home, sell your old property, then pay off the loan.
Here are some additional details to consider with bridge loans:
- Your current residence is used as collateral for the loan.
- These loans may only be set up to last for a period of six to 12 months.
- Interest rates are higher than those you can get for a traditional mortgage.
- You need equity in your current home to qualify, usually at least 20 percent.
Also keep in mind that there are several ways to repay a bridge loan. You may be required to start making payments right away, or you may be able to wait several months. Make sure to read the terms and conditions of your loan so you know where your financial obligations begin and end.
Risks of taking out a bridge loan
Taking out a temporary loan so you can purchase a new home may sound ideal, but as with most financial products, the devil is in the details. While these loans can help in a pinch if you aren’t able to purchase a property through other means, there are notable disadvantages.
They can cost more than alternatives
David Reiss, a professor at Brooklyn Law School and the academic program director at the Center for Urban Business Entrepreneurship, says the biggest downside of these loans is the price tag. Because bridge loans are meant to work for the short term, lenders have a much shorter timeline for turning a profit. As a result, “they typically charge a few percentage points higher than what you would pay with home equity loans,” says Reiss. Not only that, but they come with closing costs that may be expensive, and can vary from loan to loan.
So, even if the loan is short-term, it will likely cost you more than borrowing the money through a traditional mortgage by selling your existing home first, or through other means.
You’re taking on more debt
Another inherent risk with bridge loans: You’re simply borrowing more money. “The loan is secured by your home, so you have another mortgage,” Reiss says. “If you don’t make payments, then you could face late fees and financial turmoil.”
You can’t predict when you’ll sell your home
And if you’re unable to sell your home and your new or old monthly mortgage payments are taking a big chunk of your income, you could have trouble meeting all your financial obligations.
Reiss offers one other scenario in which a bridge loan could spell financial trouble: if the real estate market sours.
“You might assume you’ll sell your home easily, but that isn’t always the case,” says Reiss. “Unexpected events can screw up your plans to sell your home, so if you end up carrying multiple mortgages, you could potentially end up in trouble.”
According to Reiss, taking out a bridge loan could easily leave you with three home loans — your old mortgage, your loan, and your new mortgage — if the housing market slumps inexplicably and you can’t sell.
“This may not be a problem temporarily, but it can cause financial havoc in the long run,” he says. “You’ll be stuck with the unexpected expense of carrying all these mortgages.”
Falling behind on payments can lead to foreclosure on your old home, your new property, or both.
Advantages of a bridge loan
Applicants who are well aware of the risks of this financial product may still benefit from choosing this option. There are notable advantages, Reiss says, especially for certain types of buyers.
They can give you an edge in competitive markets
Bridge loans are “the kind of loan you get when you need to move forward and you can’t do it any other way,” says Reiss. If you are absolutely dead-set on purchasing a property and struggling to make the financials work, then a bridge loan could truly save the day.
This is especially true in housing markets where homes are moving quickly, Reiss notes, since a bridge loan allows you to buy a new home without a sales contingency in the new contract. What this means is, you’re able to write an offer on a new property without requiring the sale of your old home before you can buy.
This can be quite advantageous “in a hot market where sellers are getting lots of offers and you’re competing against other buyers who are paying in cash or making offers without a contingency,” Reiss says.
Bridge loans may be more convenient than the alternatives
Reiss also says that, while there are other loan options to consider for buying a new home, they aren’t always feasible in the heat of the moment. If you wanted to purchase a new home before selling your old home and needed cash, you could consider borrowing against your 401(k) or taking out a home equity loan, for example.
Yes, these options may be cheaper than getting a bridge loan, Reiss acknowledges. The problem is, they both take time. Borrowing money from your 401(k) may take several weeks and plenty of back and forth with your employer or human resources department, and home equity loans can take months. Not only that, but it might be difficult to qualify for a home equity loan if your home is for sale, Reiss says.
“A home equity lender who catches wind of your intent to sell your home may not even loan you the money since it’s fairly likely you’ll pay off the home equity loan quickly, meaning they won’t turn a profit,” he says.
Bridge loans, on the other hand, could be more convenient and timely because you may be able to get one through your new mortgage lender.
Four good reasons to take out a bridge loan
With the listed advantages and disadvantages above in mind, there are plenty of reasons buyers will take on the risk of a bridge loan and use it to transition into a new home. Reasons consumers commonly take out bridge loans include:
1. You want to make an offer on a new home without a sales contingency to improve your chances of securing a deal.
The most important reason to get a bridge loan is if you want to buy a property so much that you don’t mind the added costs or risk. These loans let you make an offer without promising to sell your old home first.
2. You need cash for a down payment without accessing your home equity right away.
A bridge loan can help you borrow the money you need for a down payment. Once you sell your old home, you can use the equity and profit from the sale to pay off your loan.
3. You want to avoid PMI, or private mortgage insurance.
If most of your cash is locked up as equity in your current home, you may not have enough money to put down 20 percent on your new home and avoid PMI, or private mortgage insurance. A bridge loan may help you put down 20 percent and avoid the need for this costly insurance product.
“But you would need to net out the costs of the bridge loan against the PMI savings to see if it is worth it,” says Reiss. “And remember, once you have sold the first home, you could use the equity from that home to pay down the mortgage on your new home and get out of paying PMI.”
According to the Consumer Financial Protection Bureau (CFPB), you may have to order an appraisal to show you have at least 20 percent equity to get PMI taken off your new loan, and even then, it can take several months.
“So, we might be talking about six to 12 months of avoided PMI payments if you were planning on using the equity from your old home to pay down the mortgage on your new home,” says Reiss.
4. You’re building a new home.
A bridge loan can help you pay the upfront costs of building a new home when you aren’t yet prepared to sell your old one because you still need a place to live.
How to qualify for a bridge mortgage loan
Because bridge loans are offered through mortgage lenders, typically in conjunction with a new mortgage, the requirements to qualify are similar to getting a new home loan.
While requirements can vary from lender to lender, you commonly need to meet the following criteria for a bridge loan:
- Excellent credit
- A low debt-to-income ratio
- Significant home equity of 20 percent or more
Typically, lenders will approve bridge loans at the value of 80 percent of both the borrower’s current mortgage and the proposed mortgage they are aiming to attain. Let’s say you’re selling a home worth $300,000 with the goal of buying a new property worth $500,000. In this example, across both loans, you could only borrow 80 percent of the combined property values, or $640,000.
If you don’t have enough equity or cash to meet these requirements — or if your credit isn’t good enough — you may not qualify for a bridge loan, even if you want one.
Fees and other fine print
Before you take out a bridge loan, it’s important to understand all the costs involved. Here are some fees and fine print you should look for and understand:
Since bridge loans vary widely from lender to lender, the fees involved — and the costs of those fees — can vary significantly as well. Common fees to look for include an origination fee that can be equal to 1 percent or more of your loan value. You will also likely be on the hook for closing costs for your loan, although the amount of those costs can be all over the map based on the terms and conditions included in your loan’s fine print. As example, Third Federal Savings and Loan out of Cleveland, Ohio, offers a bridge loan product with no prepayment penalties or appraisal fees, but with a $595 fee for closing costs. Borrowers may also be on the hook for documentary stamp taxes or state taxes, if applicable. Make sure to check your loan’s terms and conditions.
While it’s unlikely your loan will include any prepayment penalties, you should read the terms and conditions to make sure.
Payoff terms and conditions
Because all bridge loans work differently, you need to be sure when your loan comes due, or when you need to start making payments. You may need to make payments right away, or you might have a few months of wiggle room. Because there are no set guidelines, these terms can vary dramatically among different lenders.
Tips to sell your home quickly and avoid a bridge loan
If you’re on the fence about getting a bridge loan because you’re worried about short-term costs or the added layer of risk, try to sell your home quickly instead. If you’re able to sell, you may be able to access your home’s equity and avoid a bridge loan altogether, while also eliminating the possibility of getting “stuck” with more than one home.
We spoke to several real estate professionals to get their tips for selling your home quickly. Here are their best tips for getting your home ready to sell in a short amount of time:
Tip #1: Do some quick outdoor cleanup and landscaping work, then try to make your home as neutral as possible.
“To get people inside, they need to like the outside of your house,” says Nancy Brook, a Realtor who sells properties with RE/MAX of Billings, Mont. “Trim trees and shrubs, treat weeds, and mow and trim lawns.”
You should also make sure that there’s no chipped or peeling paint, she recommends. “And if your home is anything but a neutral color, you should seriously consider painting it.”
Tip #2: Get rid of half your stuff (or more).
As Brooks notes, most real estate agents suggest that sellers pack up most of their personal items and remove them from the house when they’re trying to sell. This helps people declutter while also making their property more appealing to people who might be turned off by someone else’s personal photos and items.
“Pack up or get rid of rid of paperwork, knick-knacks, personal photos and collections,” says Brooks. “Any furniture that obstructs a walkway should be eliminated. Get rid of any unnecessary dishes, pots, pans and small appliances in your kitchen. All the excess gives a junky appearance.”
Tip #3: Deep-clean from top to bottom.
While cleaning seems like an obvious first step, it is often neglected, notes Trina Larson, RE/MAX Realtor and selling specialist from Potomac, Md.
“You would never purchase a dirty car or a dirty new jacket,” she says. “Get everything as clean as possible, and try to make your house look brand-new.”
Items on your to-clean list should include corners, edges of baseboards, light fixtures, windows inside and out, your home’s siding and anything that isn’t in pristine condition.
Tip #4: Get rid of off-putting smells.
If you want to sell quickly, your house should smell clean and inviting, Larson suggests. “Your first step is to remove every offensive odor,” she says.
Go through each room and take inventory of what you smell. “Pet urine is especially heinous, and there is only way to remove it,” she says. “You have to go in and replace the carpet where the accident happened. Although it might seem like an expensive task, it is worth every penny. No cooking or animal odors.”
Basic cleaning can also help remove smells. The cleaner your home, the fresher it will seem to potential buyers.
Bottom line: Is a bridge loan worth considering?
If you want to buy a home quickly and don’t have time to sell your home, a bridge loan could help. Likewise, bridge loans can be a good option for people who are moving or building a new home and need the capital to make the sale go through regardless of cost.
On the other hand, such loans may not be the best choice for consumers who don’t want to risk getting stuck with two homes and multiple payments. They’re also a poor choice for buyers who don’t want to pay any additional closing costs or interest payments to get in the home they want.
In the end, only you can decide if the risk of getting a bridge loan for your new home is an acceptable one.