In 2018, 78 percent of homes in the United States were purchased using home loans as opposed to cash. Among the most popular home loans in the country today are bridge loans.
But what is a bridge loan, and how does it work?
Well, ordinarily, you’d need to find a buyer for your current house before you make an offer on a new home. The money you received from the sale of your current home would then fund the down payment for your next one, providing a seamless transition from one house to the next.
Unfortunately, this isn’t always how it works. Transactions can take a longer time than you expect, and you risk missing out on your dream home waiting for your current home to sell. A bridge loan allows you the option to access your home equity before you sell.
But how do you know whether a bridge loan makes sense for you? In this article, we explain several pros and cons of bridge loans to help you make an informed decision.
The Pros and Cons of Bridge Loans
Bridge loans can help home buyers snatch up homes a lot more quickly. Here are some of the benefits of these types of loans.
A Bridge Loan Makes You Attractive To Sellers
One of the frustrating things in the home buying process is the bidding war between multiple aspiring home buyers. A bridge loan can put you ahead of other buyers because your offer doesn’t come with a home sale contingency.
A lot of home buyers make offers that have a home sale contingency, meaning that if their current home doesn’t sell, they can back out. This, of course, makes sellers nervous. Bridge lending guarantees you the funds you’ll need to buy the home and increases your odds of a winning bid.
A Bridge Loan Gives You Flexibility When Buying and Selling
With a bridge loan, it’s possible to finance a new home before your current one sells. In short, you don’t need the sales proceeds from your old home to begin the buying process of your new home. This gives you much more freedom when shopping around for a home.
Bridge loans help ensure that buyers don’t miss out on their dream homes. When your dream house goes on the market, you can move quickly to make an offer.
You Don’t Need To Start Making Immediate Payments
Now that you’ve discussed the terms of your loan with your lender, what comes next? Well, one thing you’ll love about bridge loans is that most lenders allow you some breathing space before requiring you to start making payments.
Generally, bridge loans are short term and last about a year or less. Some lenders will allow you four to six months before you begin to make payments. Others will even wait until your old home sells, so you have the money to begin paying off the loan.
You Can Get Approved Fast
Typically, the application, approval, and funding process is much faster for bridge loans than for conventional mortgage loans. For this reason, you can make an offer and close on your new home a lot more quickly.
While bridge loans do have some significant benefits for aspiring home buyers, they certainly do have their drawbacks as well. Here we cover three important ones.
Your Total Debt Increases
How big is your old mortgage? By taking a bridge loan, you’ll end up with additional debt. But what’s the problem with that?
Well, there are two potential issues.
First, when applying for a conventional mortgage on your next home, you’ll need to be able to come in below the “debt to income”, or DTI, minimum that lender requires. Taking out a bridge loan will increase your monthly debt, and this increases your DTI. If you are over the limit, you may not be able to qualify for a mortgage loan and will need to back out of your purchase contract.
Second, if your old home fails to sell or sells for a price that’s too low to cover your debts, you’ll have to come up with more assets, in addition to your home equity, in order to pay off the bridge loan.
Of course, you can always apply to refinance from the bridge loan to a long-term loan, but what’s the guarantee that you’ll get approved? To avoid these situations, always make sure you have stellar credit, an emergency fund, and ample income before considering a bridge loan.
Bridge Loans are Inherently More Risky
The moment you take out a bridge loan, the clock for selling your old home is ticking. A bridge loan typically lasts for six months to a year, so it’s essential to make sure that your home sells within that period, so you have the money to pay off the loan.
What if you have a buyer already lined up? That’s certainly a great thing, provided they don’t back out of the sale at the last minute. Unfortunately, there’s no way to know whether your buyer will be able to sell their existing home, get financing, and be happy with the inspection and appraisal report on the home they’re buying from you.
Moreover, home sellers are always at the mercy of market conditions. Should the market swing in favor of home buyers, you’ll have trouble selling your old home for the price you had anticipated, or selling at all.
Bridge Loans Have Higher Interest Rates
The amount of risk that bridge loans carry is much higher than that of conventional home loans. To protect themselves, lenders charge higher interest rates on bridge loans than they would usually charge for traditional mortgages. Sometimes, the interest rate on bridge loans can be 10% or higher, which is at least double that of conventional mortgages.
So how will this affect you?
Well, first of all, you’ll put a strain on your budget to pay off the loan. Remember that the longer your loan term is, the more interest you’ll have to pay. Don’t forget about all other additional costs like origination fees, appraisals, and closing costs.
Bridge Loans Don’t Remove Your Financing Contingency
Most buyers get a bridge loan to cover the down payment on their new home. However, you still have to qualify for a mortgage by the close date listed in your purchase contract. This requires you to add a financing contingency to your purchase contract, which makes it less attractive to the seller, and may cause them to turn down your offer in favor of an all cash bid. So just remember: a down payment bridge loan removes your home sale contingency, but not your financing contingency.
Buy a Home Today Using a Bridge Loan
After evaluating the pros and cons of bridge loans, do you think they’re a suitable financing option for you?
One thing that’s for sure is that a bridge loan can give you an edge in today’s tight housing market. The most important thing is to determine whether or not you can afford it.
If you’re interested in a calmer, more convenient way to buy your next home with much lower fees than a bridge loan, another option is to use our funds to make an all cash offer before you sell and only pay 1.9 percent of your new home purchase price. Learn how Homeward works.
Experience a calmer, more convenient way to buy
Take less than 10 minutes to get approved.