You’ve found the house of your dreams. It’s everything you ever wanted, and more. There’s just one catch. You haven’t sold your current home yet, and if you don’t act quickly, you could lose that great, new place. The answer to your dilemma may lie in a bridge mortgage.
A Bridge Mortgage
A bridge mortgage, also known as a bridge loan, allows you to “bridge” the gap between the time it takes to sell your present home and buying a new one. Gap financing is another common term for this form of lending. Your current home serves as collateral for your new purchase. Generally, you can finance as much as 80 percent of the value of both properties. That means if you’re selling your home for $300,000, and the new home’s cost is $500,000, you can borrow as much as $740,000. Once you sell your old home, you’ll pay off your bridge loan. You then apply for a new mortgage for the new dwelling. If you qualify, you’ll receive your bridge loan fairly quickly, usually within two weeks. It’s a short-term loan, with terms that don’t exceed one year, and often much less. It’s also an expensive loan. Expect to pay not only exceptionally high interest rates, but also significant origination fees. Expect to pay for an appraisal of the house you plan to buy, and possibly an appraisal of your current home.
Bridge Loan Reasons
While buying a new home while still owning your old home is the most common reason a bridge mortgage is sought, it’s not the only one. If you plan to buy a home at auction, a bridge loan is a way to secure funding for the purchase. It’s also useful if you’re planning to invest and sell the new home, not live in it yourself. Perhaps you need to renovate your current home before putting it on the market. A bridge loan can help you pay for substantial renovations, and you then put the house up for sale. Of course, that only makes sense if you are sure your house will sell fast once it’s up to snuff. If you’re planning to build a home, you may need to acquire funding for construction before taking out a conventional mortgage, and a bridge loan will indeed fill that gap. Some people must relocate quickly, and don’t have the time to wait until their home sells. The bridge loan allows them to purchase another home in another state or region, move in and put their old home on the market.
Bridge Mortgage Structure
When you receive a bridge loan, you can use it in one of two ways. The first is by using the funds to pay off your present mortgage. If there are funds left over, they can go toward the down payment on the new house. The other method is using the bridge loan as a second mortgage, with all of the monies going toward the new home.
Bridging Finance and Hot Markets
With such a high interest rate and accompanying fees, why would anyone consider a bridge loan? Well, you don’t want to lose that dream property, and you also don’t have to worry about contingencies in the sales contract. When a market is hot and a property desirable, the seller doesn’t want to deal with a financing contingency in the contract, and the possibility the buyer will back out of the deal. You can snag that home without a financing contingency if you’ve taken out a bridge mortgage, but you pay for the privilege. However, bridge loans only work in a seller’s market, when properties are moving fast, and you’re confident your house will sell quickly. It makes no sense to obtain a bridge loan in a buyer’s market when the process is moving much more slowly. A lender is unlikely to approve a bridge loan in a slow market because there’s a question of how long it will take you to sell your current house. In a slow market, a seller isn’t usually as concerned about financing contingencies, as long as someone is interested in purchasing the property.
Qualifying for a Bridge Loan
If your credit rating isn’t stellar, your debt-to-income ratio less than ideal and you have less than 20-percent equity in your current abode, don’t stop to consider a bridge loan. Lenders approve such loans only for the most well-qualified applicants since bridge loans are risky. You must qualify to own two homes, even if only for a short time. The lender also is assuming you can sell your home relatively quickly, and you should feel the same way before taking out a bridge loan. In a worst-case scenario, should your home not sell, you could face not only the exorbitant rates you’re paying on the bridge loan but a possible foreclosure when the loan is due. A lender may offer a short extension, but that’s about all you could expect if your house still hasn’t sold.
Bridge loans are relatively rare today. That wasn’t the case before the housing crisis back in 2008. The risk lies not so much in your current home not selling, which is a concern, but in the financing of the person who wants to buy your home. If their financing goes through, the bridge loan works as advertised. If their financing falls through, the bridge collapses.
Finding a Lender
Due to the risk, finding a bridge loan lender may prove difficult. For best results, if you have the necessary qualifications, look locally and deal with your bank or credit union first. What you don’t want to do is go through one of the online lenders offering to solve all your issues with “fast cash.” You’ll pay even higher rates than with a standard lender.
Bridge Finance Alternatives
If you’re not someone likely to win bridge loan approval from your lender, or you don’t like the idea of paying high rates and fees, there are alternatives. You can take out a home equity line of credit on your current home to purchase your new home. Under the Tax Cuts and Jobs Acts bill signed into law in late 2017, the home equity loan is no longer tax deductible when used for this purposes, but it’s still likely a better deal for many people than a bridge mortgage. Unlike a bridge loan, the terms for home equity loans are much longer, often as much as 20 years, and interest rates aren’t nearly as high. That doesn’t mean a home equity loan is without risk, but it’s less risky than a bridge mortgage. The worst-case scenario when your first home doesn’t sell as expected involves you paying your original mortgage, your new mortgage and your home-equity loan. Default on the latter, and you could face foreclosure of the old home. One caveat: Lenders will usually not offer a home equity line of credit on a house that’s on the market, so you must apply for it before putting your house up for sale.
Other options include borrowing against your 401(k) to secure your new home or using other assets as collateral for a loan. That may include your stock, bond or mutual fund portfolio, or a valuable boat, art collection or the like.
A graduate of New York University, Jane Meggitt's work has appeared in dozens of publications, including PocketSense, Zack's, Financial Advisor, nj.com, LegalZoom and The Nest.