The prospect of selling an old home and buying a new one is exciting. But for buyers who have all their cash tied up in their existing home equity, it can also be stressful. If you’re like most buyers, you need to access your existing home equity in order to pay the down payment on your new home.
To get the equity out of your current home before it sells, you have several options. Some of your options include tapping into your existing home equity using either a home equity loan or a home equity line of credit, or taking out a temporary loan through bridge loan lenders until your current home sells.
Are any of these right for you? Let’s take a look.
What is a Home Equity Loan?
A home equity loan is based on the amount of equity you have in your home and uses your home as collateral to secure it.
- Your interest rate will be fixed. Even if interest rates begin rising, your rate will stay the same, guaranteeing your payment stays the same month after month.
- You’ll get a lump sum. Once the process is finished, you’ll get all the equity available in one lump sum that you can put toward your next home purchase.
- There are fees. While you’ll get a fixed interest rate, you’ll pay traditional mortgage origination fees and closing costs. This is, again, because you are creating an entirely new home loan.
- Your home is collateral. If your home stays on the market for a long period of time and you become stuck in a bad financial situation, you could lose your home. It’s the collateral that you’re leveraging to receive your funds.
- You’ll pay a higher interest rate. While you get stability in the fixed interest rate, you’ll pay a slightly higher rate than you would on a HELOC, which has a lower rate that adjusts up or down based on the market.
While a home equity loan is great for debt consolidation or home improvements, it isn’t the best idea if you just need the funds temporarily. If you’re wanting to pay off higher interest debts or use the funds to improve your home, then a home equity loan is worth the additional fees you’ll pay. But those closing costs and fees mean you’ll lose a chunk of your home equity in the process, which is a high price to pay for a temporary solution like coming up with down payment funds for a new home purchase.
What is a HELOC?
A HELOC, or home equity line of credit, is a revolving line of credit that uses your home equity as collateral.
- You’ll get lower interest rates. Because your home functions as collateral, you’ll get lower rates than other loan types, just like a home equity loan. However, because HELOCs have a variable interest rate, your initial rate will be lower than the rate on a home equity loan.
- You use the money when you need it. Instead of one big lump sum, you pull the amount of money you need when you need it, and only pay interest on your outstanding balance.
- Your payments will be interest-only at first. During the initial term of a HELOC, known as the draw period which typically lasts the first 5-10 years, you’ll only need to make interest payments. After that, you’ll also need to start paying back the principal.
- Some or all of your interest payments may be tax-deductible. The tax laws have been changing in recent years, but you may be able to deduct the interest on any funds that are withdrawn and spent on home improvements, subject to certain limitations.
- Your interest rate could rise. Once your introductory rate expires, you will pay whatever the loan’s rate adjusts to, and it can rise or fall based on the loan’s benchmark index.
- It is harder to budget for. Because your interest rate is variable, your payment will be too.
- You will have to pay the principal at some point. When your draw period ends, you will have to begin paying the larger principal and interest payment. This means a pretty massive jump in your payment. If you fail to budget for this, you might have a financial headache on your hands.
- You will pay fees. Many HELOC loans come with additional fees that must be paid, depending on the terms.
A HELOC is a great choice for having access to funds if you have occasional purchases that need to be made and you want lower fees and rates than credit cards or unsecured personal loans. But trying to bridge the gap between selling and buying a new home isn’t a smart use of a HELOC. You’ll pay a lot of fees upfront to setup the HELOC and, like a home equity loan, you’ll also be taking on additional monthly debt payments which may disqualify you from getting a mortgage on your new home because you won’t meet the lender’s debt-to-income (DTI) requirement.
What is a Bridge Loan?
A bridge loan is a special type of loan created specifically for the situations that arise when you need to sell one home to buy another. Bridge loan lenders will generally allow you to borrow up to 80% of your existing home’s value, so you can pay down your existing mortgage and use the remainder towards the down payment on your next home. If you don’t have at least 20% equity in your existing home though, you usually aren’t allowed to take out a bridge loan and it wouldn’t help in any case, since there wouldn’t be enough equity to tap into.
A bridge loan can give you the funds to close quickly and without as many contingencies while you wait for your current home to sell.
- You’ll get quicker financing. The application process is shorter than waiting for a home equity loan to close.
- You can remove contingencies from your offer. This means when you find a home you love, you can make sure your offer stands out to the seller. Many new home buyers find themselves standing in their prospective dream home, but can’t yet make an offer on it because their old home hasn’t sold. You can put in an offer with a contingency that says your existing home has to sell or else you can back out, but in a hot housing market, you face losing your dream home to someone who doesn’t have these contingencies.
- Slightly higher interest rates. Because you’re getting money quickly with less hassle, you’ll pay a slightly higher interest rate.
- You need to have sound finances. Because you’re asking for money based on the premise that your house will sell, you’ll need to qualify to receive a bridge loan with good credit and debt-to-income ratios, and you’ll typically need at least 20% equity in your existing home
A bridge loan is a decent short term fix to bridge the gap between your old home and your new one. Easy and quick to obtain, you can be moving in no time.
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