What Exactly Are Bridge Loans?
The Pros and Cons of Bridge Loans
A buyer typically takes out a bridge loan so they can buy another home before they sell their existing residence to raise the cash for a down payment. It 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 whether taking one is right for you.
- Bridge loans allow homebuyers to close the deal on a new home before they have sold their existing home.
- Bridge loans typically come with higher interest rates than home equity loans, and they can cost thousands of dollars to establish.
- Even though the buyer plans to sell their old home, they are technically owning two homes at once, and lenders will consider whether they're qualified for this before issuing a bridge loan.
What Is a Bridge Loan?
A bridge loan is a temporary loan that's secured by your existing property. It "bridges" the gap between the sales price of your new home and your new mortgage on that residence in the event that your existing home doesn't sell before closing. 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 can help you decide if it makes sense for you.
A homebuyer can purchase a new home and put their existing home on the market with no restrictions.
You might gain a few months free of payments.
Under certain circumstances, you can still buy a new home even after removing the contingency to sell.
A bridge loan is typically more expensive than a home equity loan.
You must be able to qualify to own two homes.
Handling two mortgages at once plus the bridge loan can be stressful.
Benefits of Bridge Loans for Homebuyers
A buyer can immediately use the equity in their existing house to buy a new home, without having to wait until the old home sells, when they use a bridge loan for a real estate transaction.
Another benefit to bridge loans is that they might not require monthly payments for the first few months. They offer homeowners the flexibility of paying when they have the cash flow, at least for a period of time.
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.
Drawbacks of Bridge Loans for Homebuyers
You might end up paying higher interest costs on a bridge loan than you would on a home equity loan. Typically, the rate will be about 2% higher than that for a 30-year, standard fixed-rate mortgage.
Additionally, some people feel stressed when they have to make two mortgage payments while they're accruing interest on a bridge loan. It can be even more stressful if the home they're trying to sell isn't getting any offers.
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 period of 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. Most lenders will restrict the home buyer to a 50% debt-to-income ratio if the new home mortgage is a jumbo loan, however.
Average Fees for Bridge Loans
Rates will vary among lenders and locations, and interest rates can fluctuate as well. 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. The administration fee might be 8.5% and the appraisal fee might be 4.75% on a $10,000 loan. Certain fees will be charged at a higher rate than others.
Bridge loan fee examples based on a $10,000 loan include:
- Administration fee: $850
- Appraisal fee: $475
- Escrow fee: $450
- Title policy fee: $450+
- Wiring Fees: $75
- Notary fee: $40
There's typically a loan origination fee on bridge loans as well. 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. And many lenders won't lend on a home equity loan if the home is on the market.
The Bottom Line
You can fund a down payment for the move-up home in one of two ways if you don't have the cash for a down payment and your existing home hasn't sold yet. You can finance a bridge loan, or you can take out a home equity loan or a home equity line of credit.
In either case, it might be safer and make more financial sense to wait to sell your existing home first before buying your next home. 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 for the duration.
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." But this is generally only advisable if you're sure your home will sell, or if you have a plan in place in case it doesn't.