What Are Bridge Loans?
4 minute read UPDATED: June 06, 2022
Are you considering selling your current home and buying a new one, but wondering how you’ll afford the down payment and closing costs if your home doesn’t sell in time? If so, you’re not alone. This is a common situation that many individuals find themselves in.
With a bridge loan, you may be able to finance these costs and pay back the loan once your home sells. Let’s take a look at how bridge loans work and if they’re the best choice for you and your situation.
Bridge Loan: Definition
A bridge loan is a type of loan that is used as a short-term solution for individuals who are unable to secure more permanent financing. For example, a bridge loan is commonly used for the period of time between buying a new house and selling your current home. When you don’t have the profits from the sale of your home yet to use toward the down payment on your new one, a bridge loan can assist you.
How Does A Bridge Loan Work?
Bridge loans are sometimes referred to as interim, gap or swing financing. They’re used to cover the short period of time in between when financing is needed and when you’re able to acquire it. To apply for a bridge loan, you’ll need to contact a lender that offers this service.
Most of the time, bridge loans are used to help cover the closing costs when purchasing a new home while selling your existing home. They typically require some form of collateral to be put down and have a shorter loan term, around one year.
With a bridge loan, the individual borrowing the loan will tap into the equity in their current home to use it as the down payment on the new home. Once the home sells, they can repay this money to the lender.
When To Use A Bridge Loan
There are many situations where using a bridge loan makes sense. For example, you may want to consider using a bridge loan if any of the following situations apply to you.
- You cannot afford the down payment on the new home before selling your current home.
- You’re purchasing a new home in a seller’s market where the homes are selling faster.
- The seller is not willing to accept an offer contingent on the sale of your current home.
- You prefer to close on the new home first.
- The closing date for the new home is scheduled before the closing date of your current home.
Bridge Loan Costs
Although bridge loans can be helpful for accessing the temporary funding that you need to purchase a new home, they often come with higher costs than other loan options. Interest rates for bridge loans tend to average around 2% higher than the prime rate.
On top of these high interest rates, you’ll also need to factor in the closing costs and fees of a bridge loan. These fees are typically around 1.5% – 3% of the total loan amount. Included in these fees are appraisal fees, escrow fees, origination fees, title fees and notary fees.
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Pros And Cons Of Bridge Loans
Wondering if a bridge loan is worth it? Undertaking a new loan during an already stressful time can be a large undertaking for some individuals in the home buying process. Consider these pros and cons before contacting a lender to obtain a bridge loan.
- Borrowers can access their funds immediately.
- They provide you with greater flexibility and peace of mind during the transition from selling to buying.
- It’s usually an easy application process with a fast turnaround time.
- They typically have higher interest rates than other types of loans.
- Most lenders require borrowers to have at least 20% equity in their current home.
- Bridge loans are secured so you’ll need to provide collateral.
- Most lenders prefer that you also use their services to obtain your new mortgage as well.
- You may have to manage two mortgages at the same time.
Bridge Loan Alternatives
If you’re not sure if a bridge loan is right for your situation, there are a few other alternatives that you may want to consider.
Home Equity Loans
Home equity loans allow you to borrow against the existing equity in your home to obtain financing that can be used for a variety of purposes. With these loans, your home is used as collateral. However, they typically have much longer loan terms and more favorable interest rates than bridge loans offer. Keep in mind that home equity loans are essentially a second mortgage, so you will need to carry two at the same time and may even end up holding three at once if you are unable to sell your current home in the time you’d hoped to.
Home Equity Line Of Credit (HELOC)
With a home equity line of credit, or HELOC, a homeowner can take out a line of credit against the equity in their current home. With longer repayment periods and favorable interest rates, they may seem more attractive than bridge loans for individuals looking to buy and sell at the same time. Some HELOCs may charge prepayment fees, so it’s important to look into this if you plan to pay this line of credit off after the sale of your current home is finalized.
Another alternative to bridge loans is an 80-10-10 loan. With this kind of loan, home buyers can obtain a mortgage that covers 80% of the home’s purchase price and put lower than 20% down on the house. The terms of this loan require borrowers to pay 10% down and then obtain two mortgages. One mortgage will be 80% of the new home’s purchase price and the other will cover the remaining 10%. Once your current home has been sold, excess funds can be used to pay off the second 10% mortgage on the new home. This option can help borrowers avoid additional fees such as private mortgage insurance.
Bridge loans can be helpful for home buyers who find themselves having trouble selling their current home before the closing date on their new property. However, these loans can come with high interest rates and if used incorrectly, could leave you in a bad financial situation. Consider the pros and cons before applying for one and see if an alternative option might be better suited for you.
If you feel that an alternative loan better fits your needs, be sure to do your research to find the best option for you.
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