What is a bridge loan in real estate?
You've probably asked this question at least once if you're buying a new home—especially if you think you might have to close on the new home before you sell your current one.
Bridge loans exist to solve that exact situation, but that doesn't mean that they're right for you. A bridge loan can be risky and expensive, so consider it carefully before you decide.
What are bridge loans and how do they work?
As its name indicates, a bridge loan gets you from one mortgage to another. You to borrow the money for your next down payment from the equity that you've built in your current home. When you sell the home you're in, you use that income to pay off your bridge loan.
Bridge loans can help to get you out of a tight spot, but they can be risky. Now that you know what bridge loans are, the next step is to consider the pros and cons in detail.
Pros of Bridge Loans
Pro #1: You don't have to submit a contingent offer.
An alternative way of handling a home purchase before your current home sells is the contingent offer. This is also just what it sounds like—your offer is contingent on the sale of your existing property.
Contingencies are common, but they're also risky.
A standard contingency agreement takes the home you're buying off the market while you try to sell your home. But what if your home doesn't sell? What if your buyer also submits a contingency offer?
To sidestep this uncertainty, sellers often accept a contingency offer only if it has a first right of refusal clause. That means the home you're buying stays on the market and if the seller receives a better offer, you have a certain amount of time (a couple of days, typically) to lift your contingency and buy whether or not the home has sold. Otherwise, the seller can terminate the contract and sell to the other buyer.
A bridge loan gives you the cash for a down payment so you don't have to make a contingent offer. If the seller accepts your offer, no one can take it away.
Pro #2: No temporary move; no stopgap housing.
Selling before you buy can be risky as well. Imagine that your home sells quickly and your buyer wants to move in right away, but you haven't closed on your new place yet. You'll have to pack up your belongings, find a place to live in the meantime, and then move again into your new home.
That's not only inconvenient, it's also costly. ConsumerAffairs estimates that the cost of a local move averages between $600 and $1,000 for a three-bedroom home and up to $2,000 for a four-bedroom home. If either of your moves involve distances of more than 100 miles, you'll pay more.
Pro #3: Enjoy a few months without payments.
Many bridge loans don't require payments for the first few months of the term. Not having that extra payment can make a big difference if you're already facing moving expenses and possibly making mortgage payments on two houses.
Also, with a grace period in place, you can take time to accept an offer on your home. Just be aware that you'll still be paying interest, so you don't want to wait too long.
Cons of Bridge Loans
Con #1: You have to qualify for two mortgages plus the bridge loan.
Bridge loans are difficult to secure because you have to prove that you can afford two mortgages plus the bridge loan. This could bring your debt-to-income ratio above what lenders will accept.
According to the Consumer Financial Protection Bureau, lenders usually won't give you a mortgage with a debt-to-income ratio of 43 percent, meaning that your debt cannot exceed 43 percent of your gross monthly income with the loan in place.
What does that mean in dollars? Consider that the average monthly mortgage payment is $1,030. Two of those brings you up to $2,060, which is already almost 41 percent of the median household monthly income in the US.
Payments on a bridge loan would easily bring you above that 43 percent, and that's not even considering any other debts like car payments or student loans.
Con #2: Interest rates and other costs can be high.
Bridge loans carry significant costs. First off, interest rates tend to be about 2 percent higher than the prime rate. The larger your loan and the higher your debt-to-income ratio, the more you'll pay.
Fees are high as well. Origination fees for bridge loans are often 1.5 percent to 3 percent of the loan's value. Closing costs can total hundreds or thousands of dollars, and then you have the cost of the mortgage on the new house.
So what would your total damage be? MarketWatch estimates $2,200 for a $10,000 loan, but your costs will depend on your own situation.
Con #3: It's risky.
Sure, you can pay off your bridge loan with money from your current home's sale, but what if it doesn't sell? Then you're on the hook for two mortgages as well as the bridge loan. People in this situation are likely to sell out of desperation, often accepting a lower price.
If your home doesn't sell by the time the bridge loan matures, the lender could foreclose on your existing home in order to recoup its investment.
You could also face foreclosure if you default on your bridge loan. Then you might lose your old home, your new home, or even both.
Then again, default risk isn't limited to bridge loans. You could default on any loan that you use to make a down payment.
Fortunately, it is possible to get the money for a down payment without putting yourself at risk of having no home to live in at all. One of the safest solutions is called MoveAbility, a new program by EasyKnock.
Turn Your Equity into a Down Payment – No Borrowing!
MoveAbility works as a sale-leaseback. EasyKnock buys your home and then rents it to you as a tenant, giving you an agreed-upon percentage of your equity in 13 days and reserving the rest for when your home sells on the open market.
MoveAbility isn't a loan, so you can take your equity and make your next down payment without interest rates or worries about foreclosure. It also lets you avoid having to make those dreaded contingency agreements, which can put you right back to square one in your home search.
Check it out today and learn how you can buy and sell at your own pace – no rush, no pressure, no more loans. It's safe and easy - come see how!