Considering a bridge loan? You may be if you’ve found your dream house and haven’t sold your existing one yet. Bridge loans “bridge” the gap between the sale of an existing property and the purchase of a new one. These types of loans are generally used when the market is a bit slower and selling an existing home may take longer than the typical 68 days.
Some real estate agents will suggest that you just put a contingency on your offer, stipulating that you’ll follow through with the new home purchase when your existing home sells. But this option isn’t attractive for home sellers who want to sell their homes as quickly as possible so they can move into their next one.
While many home purchase offers have some contingencies, such as a home sale or financing contingency, offers without them are much more competitive. It’s simply too risky for the home seller to pull their house off of the market and cross their fingers that all of the contingencies will be met. Because of this, the more straightforward the contract, the better the chance your offer will be accepted.
That’s where bridge loan lenders come in. They often advertise these loans as a great option for homebuyers who don’t want to risk losing the home they really want to another buyer who is able to put a clean contract on the home. But are they a good option? Let’s take a closer look.
Before you sign on the dotted line, be sure you have all of the facts. Bridge loans can help you get a new house before you sell your existing one, but they come with issues you may want to consider.
A bridge loan is a short-term loan meant to cover you until you sell your existing property. You can use a bridge loan in one of two ways. In both cases below, you can only borrow up to 80% of your current home’s value.
First, you can get a bridge loan to pay off your current mortgage and, if there are funds remaining, those will go toward your down payment. Example: You have a $100,000 home and a $50,000 current mortgage. You take out an $80,000 bridge loan, pay off your existing loan, and have $30,000 remaining to help fund the down payment on your new home.
Second, you can keep your existing mortgage and just get a bridge loan as a second mortgage. Example: Again, you have a $100,000 home and a $50,000 current mortgage. You take out a $30,000 bridge loan and use that amount toward your down payment.
In both cases above, when your home sale closes, you’ll pay off the bridge loan with the proceeds. You’ll also need to pay any fees and interest.
Bridge loans typically have a much higher interest rate than a long-term loan. This is an important consideration for a couple of reasons. First, you will pocket less money on the sale of your existing property because you will have to use some of those proceeds to pay the interest accrued on your bridge loan. Second, if you are using the bridge loan only as a down payment for the new home, you will be carrying three loans at the same time: you’ll still be paying your existing mortgage until that house sells; you’ll be paying the mortgage on your new home; you’ll be paying down the bridge loan plus its interest every month. That’s a lot of debt to carry, particularly when there’s no way to estimate exactly how long you’ll be in this situation. Only once your existing home sells will you be able to release yourself from two of these loans.
Finally, it can be difficult to qualify for a new mortgage while you also have a current mortgage and a bridge loan. This increases your debt to income ratio, which lenders watch closely. If it’s over 43%, i.e. monthly debt payments are 43% or more of your monthly qualifying income, then you may be denied when you apply for your new home loan.
Bridge loans aren’t as cut and dry as they’re sometimes advertised. Many come with terms that may not be beneficial to the borrower. For instance, some bridge loans actually charge prepayment penalties if you try to pay them off within six months of receiving the funds. So, if your existing home sells faster than you thought, you can end up paying a penalty if you pay off your bridge loan before the end of its term.
Further, you want to be sure your interest rate is fixed and your loan can be extended if necessary, with reasonable fees to do so. There’s no guarantee that your existing home will sell within the specified life of the bridge loan. Everyone assumes their home will sell quickly, but it’s not always the case. An offer you get on your existing home may be contingent on your buyer selling their home, obtaining financing, getting a bank appraisal that is within your asking price, and/or agreeing to buy despite any issues found in the inspection report. If any one of those contingencies isn’t met, your house will likely need to go back on the market.
Be sure you understand the interest rate and any fees associated with extending your bridge loan terms. All of this should be clearly indicated and agreed upon so there are no surprises.
It’s always a good idea to ask your bridge loan lender if they have any alternatives to a bridge loan. Some may be willing to work with you if you commit to getting your new long-term mortgage with them. They may be able to give you a better rate on your bridge loan and ease up on some of the restrictions. This will be purely up to the bridge loan lender and whether they have the authority to make such promises, so be certain you have any verbal agreements written down and signed by both parties.
Of course, bridge loan lenders are there to make a living. They don’t want you going elsewhere, so they may not suggest some options that don’t include them or their company. That’s okay. However, this is your investment, your money and ultimately, your decision. It’s perfectly okay to shop around and consider different options if you want to buy a home before you sell your existing one.
Bridge loans are not the only solution to purchasing a new home before your existing one has sold. In fact, it’s considered one of the more risky options.
You may consider borrowing from your 401k, but experts warn against it. CNBC wrote an article on this topic, quoting several experts who advise against borrowing from a 401k. “The Boston College research center estimates that 2 percent of assets in 401(k) plans are withdrawn annually, resulting in an average reduction in eventual retirement wealth of about 25 percent.” An advisor the article quotes says it more bluntly, “It’s not a loan; it’s a withdrawal, and it’s a really bad idea. Using the money should be your very last resort. If you still have a television set or jewelry, you haven’t exhausted all your options.”
Why the dire warning? You are reducing the amount of your retirement account and the investment growth that accrues on the amount taken out. It’s important to pay all of that money, plus the lost growth, as soon as you close on the sale of your existing home to get you back on track. Be aware that you will have to reinvest at new, potentially higher, prices. The risk skyrockets if you lose your job and there can be significant tax implications as well.
A similar scenario takes place if you pull money out of stocks and other investments to pay for a down payment on a new home.
Another option that is gaining traction is borrowing funds from a company like Homeward to make an all-cash offer on your new home without contingencies. Instead of a high-interest bridge loan, you only pay 1.9 percent of your new home purchase price to Homeward. Then you’re able to use their funds to make an all-cash offer on – and secure – your next home. You get possession of your new house as soon as Homeward closes on it, then pay them a monthly leaseback until you sell your existing home, get your new mortgage, and buy the home back from them. Best of all, you don’t have to qualify for two mortgages at once, and there are no hidden fees.
Whichever option you choose, be sure you understand all of the terms, conditions and financial implications. The last thing you want to deal with during this often stressful time is a surprise.