When you begin the process of buying a new home, hoping to sell your current house before you buy your next one can seem like a tall order. This is where a real estate bridge loan can come into play and help you get into your new home while selling your current one.
Bridging a term loan is usually characterized by gap financing, which is often used in real estate when you need funds to purchase your new house before the closing of your existing home.
How Does a Real Estate Bridge Loan Work?
Simply put a bridge loan is a short-term loan designed to cover you until you are able to sell your existing home. A bridge loan can be used in one of two ways. In both cases, 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.
Pros and Cons of Bridge Loans
As with any financial obligation or loan, there are pros and cons to this type of financing. When it comes to a bridge loan, there are a few key items to consider when deciding if it’s the right move for you.
A bridge loan will usually have a faster application process compared to a traditional loan. You may also see faster approval and funding as well. This comes in handy when you need funds quickly to close on a property.
A bridge loan makes for a fast and convenient way to get access to the funds you need until your existing home sells.
One big perk of a real estate bridge loan is that it allows you to remove any conditions associated with your current house selling. If your offer was contingent on your home selling before, with a bridge loan, you can remove those conditions and strengthen your offer.
Because a bridge loan is a short term loan, there are usually no prepayment penalties. Once you close on your home, for example, you can typically repay it with no prepayment fees.
Because of the convenience of a bridge loan, you will see higher fees and interest rates compared to other financing options. This is usually agreed upon by the borrower because it’s a short term loan and you won’t be accumulating the interest for very long.
The biggest risk when it comes to a bridge loan is having to carry up to three payments if your house doesn’t sell.
If your home doesn’t sell, for example, you’ll have to pay for your existing mortgage, your new mortgage, as well as the bridge loan. Because of this, you may run the risk of having to pay for three loans at a time.
In some cases, because your current home is used as collateral for a bridge loan, your contract may have terms that your bridge loan lender can foreclose on your current home if you fail to repay your bridge loan.
The best use case here is to only utilize a bridge loan when you know your house is selling and you just need the financing to fill the gap between your closings. This can provide you with a safety net while allowing you to close on your new home, contingency free.
Typically, a real estate bridge loan lender likes to see a borrower with a higher credit score and at least 20% equity in their home.
You’ll need to be able to show that you’re a low-risk borrower and that you’ll be able to finance the bridge loan in addition to your new mortgage payments.
The application process is still a lot less rigorous than with a traditional loan because it’s viewed as a short-term solution. You’ll see faster approvals and faster funding as opposed to traditional loans.
Repaying Your Bridge Loan
A bridge loan contract will usually come with shorter repayment terms when compared to a traditional mortgage. You’ll usually need to repay your bridge loan within 12 months or less.
Most often, a borrower will pay off their bridge loan after the sale of their current home but there are also other repayment terms that can be worked out.
Although there are a variety of options, a bridge loan will usually have a lump sum payment that is due on a certain date. Let’s say you have a closing on November 1st, your bridge loan may be due in October.
In some cases, your payments may even be delayed to give you ample time to sell your home and close. Your contract will differ depending on the terms set by the lender, amount you are borrowing, and your unique real estate situation.
Is a Bridge Loan Right for You?
Ultimately, a real estate bridge loan is one option you have to secure your new home while you wait for your existing home to sell, but it is generally considered fairly high risk and expensive financing option in most scenarios.
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