What is a bridge loan, and can it work for your home purchase?
Owning a home is a wonderful thing. But when you’re hunting for a new home, owning a home can make an already stressful process even more difficult.
If you’ve owned your current home for some time, the odds are that a good portion of your net worth is tied up. How will you access that equity to help fund your new home? How can you get the cash for a down payment? How will you compete with other homebuyers in your area?
These are questions and challenges that many homebuyers face. If this situation sounds like yours, you may have already had well-meaning friends or relatives suggest a bridge loan as an option. Let’s look at bridge loans in detail to help you understand if a bridge loan is the best fit for your homebuying situation.
What is a bridge loan and how does it work?
Bridge loans are a short-term financing solution that provides immediate cash for homebuyers. Bridge loans usually are taken out for a period of six to twelve months and can be finalized faster than a conventional mortgage.
Bridge loans get their name because they’re meant as a temporary “bridge” to give you access to cash when you need it but don’t yet have it. In real estate, that’s typically referring to the time between buying a new house and selling your old home.
Here’s an example: You just got a job on the other side of the city. You’ve owned your current home for ten years, but you want to move across town to avoid a long commute. Your home is worth $400,000, and you currently owe $225,000 on your mortgage, meaning you have $125,000 in equity.
You need cash for a down payment on your new home, but your equity is locked up in your old home. Bridge loan terms and details vary, but there are two common scenarios:
- You take out a bridge loan for the difference between your mortgage balance ($225,000) and 80% of your home’s value ($320,000). In this case, that would be $95,000. You use that money as a down payment on your new home. You’d then sell your old home, using the money to pay off the old mortgage and the bridge loan.
- You take out a bridge loan for 80% of your home’s value ($320,000). You use that money to pay off your current mortgage ($275,000), leaving you with just a $95,000 bridge loan. You use the balance as a down payment on your new home. After selling your old home, you pay off the balance of the bridge loan.
Whichever scenario your lender offers, the whole point is that the bridge loan gives you immediate cash to move forward with purchasing your new home. There’s a lot of value in this, but you should consider the risks before agreeing to a bridge loan.
Pros and cons of using a bridge loan
There are plenty of good reasons homebuyers turn to bridge loans. Bridge loans exist because they enable you to buy a new home before selling your old home. But let’s look at some specific benefits related to this foundational one:
- You’re able to access your equity. Bridge loans give you a way of accessing the equity in your old home, enabling you to put a solid down payment on your new home. It takes a long time to save for a down payment if you only save a little each month. Bridge loans are a much faster solution.
- You’re able to buy your new home before selling your old home. Buying before selling is far less disruptive. It means you can avoid a temporary rental or the need to move twice. It also allows you to prep and show your old home to potential buyers with relative ease whenever you're ready.
- You can avoid a home sale contingency. A home sale contingency is when your offer to purchase a new home is conditional on selling your old home. Sellers don’t like contingencies. A home sale contingency can make buying a new home significantly harder, especially in a hot real estate market.
All of that sounds great. But as with most things in life, bridge loans come with a catch. Before agreeing to a bridge loan, recognize that they also come with a number of cons:
- Higher interest rates and fees. Bridge loans are short-term loans. They’re riskier for lenders than conventional mortgages. These two factors mean lenders need to charge higher interest rates and fees to make bridge loans worth their time. Bridge loan interest rates vary and can be as high as 10%, significantly higher than the average conventional mortgage.
- Multiple mortgages create increased risk. Although it’s often only for a short period, using a bridge loan means you’ll effectively have two or three mortgages at once (your old mortgage, your new mortgage, and the bridge loan itself). If something goes wrong—like your old home taking time to sell— you could find yourself in a tough spot.
- Hard to find and qualify for. A bridge loan isn’t even an option if you don’t have at least 20% equity in your home. Bridge loans also aren’t offered by as many lenders, meaning it can be hard to find one that works for you. On top of that, lenders require excellent credit and high-income levels since bridge loans effectively mean you’ll be holding multiple mortgages at once.
Bridge loans have their place in the real estate market, but they can be risky for the average homebuyer. They’re typically a good fit for individuals with high income and low debt levels.
A better alternative to bridge loans
“As a realtor, I never thought bridge loans were a great option for the average homebuyer,” says Tim Heyl, Homeward’s founder and CEO. “The Homeward Cash Offer brings virtually all the benefits of a bridge loan with significantly less risk. It’s a better fit for most homebuyers.”
Buying a home while selling your old one brings very real challenges. When you choose to use the Homeward Cash Offer, we’ll buy the home you want with cash. You can move in right away and rent it from us while your new mortgage gets finalized and you sell your old home.
That means no home sale contingency (or finance or appraisal contingencies) and no disruptive experience of selling your old home while still living in it. No juggling two or three mortgage payments at the same time. No high or variable interest rates. You’ll come to the table with a cash offer, meaning you’ll have a four times greater chance of getting the home you love.
Schedule an appointment with a Homeward Advisor today if you're ready to learn more about using the Homeward Cash Offer as a better way to buy before you sell.