A lot of people talk about the stresses of first-time home buying, but what about buying when you’re still in a home you need to sell? Instead of saving up for that down payment you need to make, you’ve been building up equity and covering home maintenance and repair costs.
Suddenly you’re in a catch-22: you need the money from the sale of your current home to buy a new one, but you can’t sell your current home before you have somewhere to go.
Enter bridge loans. As the name indicates, they can provide you with the temporary funding you need to bridge the gap between one home and the next.
But how does a bridge loan work? Where do you get one, and what are the benefits and drawbacks? Let’s start with the basics on bridge loans for beginners.
What Is a Bridge Loan?
Bridge loans are short-term funding options that let you buy a new home before you sell the one you’re currently living in. There are many reasons why people apply for these loans, including:
- Needing to relocate by a certain date
- Wanting to snatch up a dream home before it’s gone
- Wanting to increase a down payment to make an offer more attractive
Without a home bridge loan, most people’s only other option is a contingent offer. A contingent offer is a clause in your purchase offer that says if you don’t sell your current home by a certain date, you have the right to cancel. Contingent offers are riskier for sellers, so they’re less likely to be accepted.
A bridge loan prevents you from having to sign a contingent offer. Instead, you borrow the amount that you need to close the sale on your new house.
Bridge loans are intended to provide temporary financing, so the term of the loan is usually between six and 12 months. A short-term means that lenders don’t have as much time to collect interest as they would with a mortgage, so interest rates and origination fees on bridge loans tend to be higher.
Expect to pay as much as 3% of the loan amount as an origination fee and interest rates as high as 8% or 10%, depending on your credit score. Your numbers may differ — people with high credit scores and low debt-to-income ratios will usually pay less for bridge loans.
The Fine Print: Qualifying for a Bridge Loan
The nature of a home bridge loan means that you’ll be applying when you’re already carrying a mortgage, sometimes two (your current one and your new one). That makes a bridge loan a risky borrow, and lenders usually compensate for that risk by making it more difficult to qualify. Expect a lender to demand:
Proof that you can afford multiple mortgages. Some lenders will need you to prove that you can afford both mortgages plus the bridge loan. Others will only count your new mortgage because they know you’re trying to sell.
Either way, you’ll need to prove that your income is high enough to manage repayments. Many lenders won’t consider you as a candidate if your monthly housing costs are more than 28% of your income before taxes, according to the credit bureau Experian.
At least 20% equity in your current home. More is better.
A property value that’s close to or above your asking price. Lenders want to be as sure as possible that your current home will sell quickly.
Pros and Cons
No loan is without its benefits and drawbacks. Bridge loans can be particularly risky bets since you carry them alongside at least one other mortgage. Make sure you know what you’re getting into before you sign.
- Faster closing on your new home. No more waiting for your existing home to close.
- No more contingent offers. In a competitive market, bridge loans can make you a more competitive buyer.
- Borrowing flexibility. Some lenders will let you make interest-only payments or defer entirely until your current home sells.
- High-interest rates and fees. Even if you defer payments, you might pay significantly more than you borrowed.
- Strict qualification requirements. You have to be an extremely qualified borrower to get a bridge loan — high credit score, low debt-to-income ratio, plenty of equity, and so on. Keep in mind, if you make $8,000 a month, all of your housing costs have to be under $2,240 to meet that 28% benchmark.
- Payments on two houses. Since you take out a bridge loan to buy a house before your current house sells, there will probably be at least a short time when you own two properties.
- Appraisal fees. Even if you’ve already paid for an appraisal, you may have to pay for another one to get a bridge loan.
A Non-Lending Alternative
If a home bridge loan is too risky or unaffordable, don’t despair — you do have other options! One is a sale-leaseback program that lets you sell your home, receive a percentage of the equity in cash, and use that to buy your next home. You stay in your current home as a tenant until you’re ready to move.
If you need to buy a home before your existing one sells, a bridge loan is a good option for beginners and can help you to avoid a contingent offer. It can be expensive, though, and it’s tough to qualify unless you have excellent credit and an income that far exceeds your debts.