A bridge loan is short-term financing for a new home’s down payment. A bridge loan can be helpful if you need additional funds to purchase a new home before selling your current home and want to make an offer without the sale of your existing home being a prerequisite.
Find out more about bridge loans and whether or not they might be a suitable fit for your homebuying needs by reading up on the process, the fees, and the pros and disadvantages.
Determine if bridge loans are a good match for your homebuying situation by learning how bridge loan’s function, the associated costs, and the pros and cons.
How do bridge loans operate?
Vendors typically use bridge loans in a bind, and their terms, costs, and conditions vary widely. Some are structured to pay off the former home’s first mortgage in full at the bridge loan’s closing, while others add the new debt to the existing one. Others require interest payments upfront or at the end of the term in the form of a fixed sum.
However, the majority share a few general characteristics:
• They typically have six- or twelve-month terms and are secured by the borrower’s old home.
• Lenders rarely extend a bridge loan unless the borrower agrees to finance the new home’s mortgage with the same institution.
Similar to applying for a conventional mortgage, your credit score and debt-to-income (DTI) ratio are used to evaluate your creditworthiness when you apply for a bridge loan. Most lenders will only allow you to borrow up to 80% of the equity in your current property.
Bridge loans can also be expensive to obtain. Before you even close on your new home mortgage, closing costs are typically a few thousand dollars, plus up to 2 percent of the loan’s original valuation, and they usually include an origination fee.
Although most purchasers obtain a bridge loan to bridge the gap between purchasing a new home and selling their old home, these loans rarely include protections for the loan holder if the sale of the old home falls through. In such a scenario, the lender could foreclose on the old property if the bridge loan extensions expire or you have difficulty selling your current home.
Given these risks, it is essential to carefully evaluate a bridge loan based on your ability to pay and the rate at which homes are selling in your market.
If you require a bridge loan,
Everyday situations where a bridge loan may be helpful include:
• A new property purchase in a market where competition is intense. Sellers are less likely to accept an offer contingent on the sale of your home when there are multiple bidders for a home. However, if you need the funds from your current home to make the payment on your new home affordable, a bridge loan may help you bridge the gap until your home sells.
A purchase of a property in need of repair. A bridge loan may be helpful if you’re purchasing a property needing substantial maintenance that doesn’t meet traditional loan requirements. For instance, Fannie Mae’s HomeStyle® Renovation loan restricts renovation funds to 75% of the purchase price plus renovation costs or 75% of the home’s “as-completed” appraised value, which may not be sufficient to purchase and renovate the house. A bridge loan could provide the additional funds necessary to complete the renovations without depleting your savings.
• A purchase of a fix-and-flip house. Consider a bridge mortgage if you are renovating and flipping a residence. If all goes according to plan, you can repay the loan once the renovations are complete. You may be able to obtain a bridge loan more rapidly than conventional financing, allowing you to acquire a property quickly.
Advantages and disadvantages of bridge financing
Pros
The funds from the bridge loan can be used for time-sensitive or immediate transactions.
A bridge loan allows you to access funds faster than a conventional mortgage.
You can defer payments until the sale of your current property, or you can make interest-only payments.
No contingency is required: Instead of placing a contingency on your new home purchase that your old home must sell for financial reasons; a bridge loan provides the funds to close on your new home even if your old home has not yet been sold.
Cons
Double the home management: You may wind up owning two homes simultaneously, resulting in double the home management and mortgage payments.
Conventional down payment: Before extending an offer for home bridge financing, most lenders require the resident to have at least 20 percent equity in their current residence.
Financing requirements: The lender may only provide a bridge loan if you consent to utilize the same lender for your new mortgage.
Higher rates: Typically, bridge loans have higher interest rates and APRs than conventional loans.
Conclusion
Bridge loans are an innovative option for homeowners who must purchase their next property before selling their current one. Using the equity in your current home as a down payment, you can purchase a new property with a bridge loan and pay it off once you sell, eliminating the hassle of buying and selling simultaneously. This type of financing can be a very convenient option for homeowners, but it can be expensive and may not work for everyone.
