What Exactly Are Bridge Loans?
The Pros and Cons of Bridge Loans
Buyers typically take out bridge loans so they can buy another home before they sell their existing residence.
That might sound like an ideal solution to a temporary cash crunch, but it's not without risk. Bridge loans are popular in certain types of real estate markets, but you should consider several factors before determining that one is right for you.
What Is a Bridge Loan?
Bridge loans are temporary loans, secured by your existing home, that bridge the gap between the sales price of a new home and the homebuyer's new mortgage, in the event the buyer's existing home hasn't sold before closing. In other words, you're effectively borrowing your down payment on the new home before your old home has sold.
Weighing the benefits and drawbacks of a bridge loan may help you decide if it makes sense for you.
A homebuyer can purchase a new home and put the existing home on the market with no restrictions
Might gain a few months free of payments
Can still buy a new home even after removing the contingency to sell under certain circumstances
More expensive than a home equity loan
Must be able to qualify to own two homes
The stress of handling two mortgages at once plus the bridge loan interest
Benefits of Bridge Loans for Homebuyers
When using a bridge loan for a real estate transaction, the buyer can immediately use the equity in their existing house to buy a new home, without having to wait until the old home sells.
Another benefit to bridge loans is that they might not require monthly payments for a few months, and they offer homeowners the flexibility of paying when they have the cash flow.
Drawbacks of Bridge Loans for Homebuyers
On a bridge loan, you might end up paying higher interest costs than on home equity loans. Typically, the rate will be about 2% higher than for a 30-year, standard fixed-rate mortgage.
Additionally, some people feel stressed when they have to make two mortgage payments while they accrue interest on a bridge loan (because of the additional funds going out each month). If the home they're trying to sell isn't getting any offers, this could become even more stressful.
How Do Bridge Loans Work?
Not all lenders have set guidelines for minimum FICO scores or debt-to-income ratios for bridge loans. Funding is guided by more of a "does it make sense?" underwriting approach. The piece of the puzzle that requires guidelines is the long-term financing obtained on the new home.
Some lenders who make conforming loans exclude the bridge loan payment for qualifying purposes. The borrower is qualified to buy the move-up home by adding together the existing mortgage payment, if any, on their existing home to the new mortgage payment on the move-up home.
Many lenders qualify the buyer on two payments because most buyers have existing first mortgages on their present homes. The buyer will likely close on the move-up home purchase before selling an existing residence, so the buyer will own two homes, but hopefully only for a short time.
Lenders have more leeway to accept a higher debt-to-income ratio if the new home mortgage is a conforming loan. They can run the mortgage loan through an automated underwriting program. However, most lenders will restrict the home buyer to a 50% debt-to-income ratio if the new home mortgage is a jumbo loan.
Average Fees for Bridge Loans
Rates will vary among lenders and locations, and interest rates can fluctuate. For example, a bridge loan might carry no payments for the first four months, but interest will accrue and come due when the loan is paid upon sale of the property. There are also varying rates for different types of fees.
Here are some sample fees based on a $10,000 loan. The administration fee is 8.5% and the appraisal fee is 4.75%. Certain fees will be charged at a higher rate than others.
Bridge loan fee examples based on a $10,000 loan:
- Administration fee: $850
- Appraisal fee: $475
- Escrow fee: $450
- Title policy fee: $450+
- Wiring Fees: $75
- Notary fee: $40
There's also typically a loan origination fee on bridge loans. The cost is based on the amount of the loan, with each point of the origination fee equal to 1% of the loan amount.
Generally, a home equity loan is less expensive than a bridge loan, but bridge loans offer more benefits for some borrowers. In addition, many lenders won't lend on a home equity loan if the home is on the market.
The Bottom Line
If you don't have the cash and your existing home hasn't sold, you can fund the down payment for the move-up home in one of two common ways. First, you can finance a bridge loan. Second, you can take out a home equity loan or home equity line of credit.
In either case, it might be safer and make more financial sense to wait before buying a home. Sell your existing home first. Ask yourself what your next step will be if your existing home doesn't sell for quite some time. You'll be financially supporting two residences.
If you're sure your home will sell, or you have a plan in place in case it doesn't, the main advantage of a bridge loan is that it allows you to avoid a contingent offer along the lines of, "I'll buy your home if my home sells."
Many sellers won't accept such a contingent offer in a seller's market. Having a bridge loan in place can make your move-up offer more attractive.