You just accepted your dream job offer and plan to move across the country for it within the next several weeks. So, you listed your home for sale and started looking for a house to buy in your new state.
Within a week, you found a property you love. Unfortunately, you need the proceeds from selling your current home to afford the downpayment. Your old house isn’t even under contract yet.
You start to panic. You committed to being in your new employer’s office in five weeks. Now, you’re down to four.
Take a deep breath. There’s a financial product designed to help you get through this nerve-wracking (but common) situation: the bridge loan.
Understanding bridge loans
A bridge loan is a short-term loan that's generally used to facilitate a real estate purchase. Also called gap financing, interim financing, or a swing loan, a bridge loan can help you buy your new home before your current property sells.
Bridge loan terms range from six months to three years but generally end within 12 months. The loan can be a small second mortgage on your current home, giving you enough funds for a down payment. You can also take out a large enough bridge loan to pay off your first mortgage and cover your down payment.
Advantages and benefits of bridge loans
Bridge loans have several advantages and benefits. Here are three of the most significant:
Many standard mortgage terms run for decades, making it feel like you’re in debt forever. However, you’ll repay your bridge loan in less than three years. If you sell your home quickly, you may only have the loan for a few months.
While every situation is different, you can generally get a bridge loan fast. You could get the funds you need in as little as a few days. (However, the loan may take two to four weeks to close).
Typically, you’ll use the cash you get from your home sale to repay your bridge loan. Some lenders will require monthly payments throughout the life of the loan, while others will defer payments until your home sale deal closes. Your lender could also require interest-only payments until your property sells.
Bonus perk: A bridge loan can help you make a competitive, non-home sale contingent offer on a property in a hot real estate market.
Cons of bridge loans
On the other hand, bridge loans do have some potential pitfalls. Here are the top three downsides:
Rates and fees
Lenders typically charge a higher interest rate for short-term loans to maximize their revenue. Therefore, bridge loan rates are roughly two percent higher than regular mortgage rates.
You’ll also have to cover loan origination fees and closing costs. You may also have to pay for a home appraisal. Generally, you can expect to pay several thousand dollars to secure your bridge loan (especially if you borrow a large sum).
Qualifying for a bridge loan is similar to qualifying for a standard mortgage. The lender will review your credit report, credit score, debt-to-income ratio, and income to ensure you’re creditworthy and can repay the debt.
You must also have at least 20% equity in your current house to be eligible. Plus, you’ll likely need to get your bridge loan from the same lender financing your new home.
Your current property is collateral for your bridge loan, so you could face foreclosure if you default. Therefore, you must ensure your budget can absorb the required payments before taking out the loan. Keep in mind that you may have to juggle multiple mortgage payments simultaneously if it takes a while for your old home to sell.
Common use cases for bridge loans
A bridge loan can be the right financial tool in other situations besides bridging the gap between buying and selling a property. Here are a few other potential use cases:
Fast home purchase
You don’t need to sell your current house for a bridge loan to make sense. You could use it to tap your home equity (the value of your residence, minus what you owe on your mortgage) for a down payment on a second or vacation property. However, if you go this route, be sure your finances can accommodate the loan payments.
You can use funds from a bridge loan to help you repair or update your home before you list it on the market. You could also use the loan to cover the renovation costs on a fixer-upper property you purchase.
Real estate investment
A bridge loan can help you purchase a house you intend to fix and flip. It could also help you make a down payment on a rental property.
Alternatives to bridge loans
While a bridge loan can be the right solution in some circumstances, you have other options. Here are a few alternatives to bridge loans:
Home equity loan
A home equity loan lets you borrow against your home’s equity. You could use the proceeds from the loan as a down payment on another property or to cover renovation expenses.
If eligible, you’ll receive your funds as a lump sum. Home equity loans generally feature a low, fixed interest rate, so your monthly payment will stay stable over the life of the debt. You’ll also have up to 30 years to pay it off.
However, you generally need good credit (credit score of 680+) and a low debt-to-income ratio (under 43%) to qualify. You must also have sufficient equity (20%+) in your home and be able to cover closing costs (up to five percent).
Home equity line of credit (HELOC)
A home equity line of credit (HELOC) also lets you borrow against your property’s equity. However, it functions more like a credit card than a mortgage.
If approved, you’ll receive a line of credit you can use to cover your down payment, closing costs, or other real estate-related expenses. You’ll only have to repay the money you use.
HELOC eligibility requirements are similar to home equity loan requirements. However, interest rates and repayment terms differ.
Your HELOC may have a variable interest rate, which means your loan payment could change over time. Your repayment term will have two phases: the draw phase and the repayment phase.
During the draw phase, you can borrow from your line of credit up to your limit, pay off the balance, and repeat the process as needed. You’ll have to make interest-only payments on your account.
During the repayment phase, your credit line closes, so you can no longer draw from it. You must make full principal and interest payments until the debt is repaid. If you have a 30-year HELOC, the draw phase generally lasts ten years, and the repayment phase runs for 20 years.
With a cash-out refinance, you take out a new mortgage that’s large enough to pay off your original loan and cover the down payment on your new home. Generally, you can borrow up to 80% of your property’s value.
Qualification requirements for a cash-out refinance are often more lenient than for a home equity loan or HELOC. You could get approved for the new mortgage with a credit score as low as 580.
Pro tip: You can’t tap into your home equity via a home equity loan, HELOC, or cash-out refinance if your property is listed for sale. You can with a bridge loan.
If you want to avoid getting a mortgage through a bank, seller financing could make sense. With seller financing, you pay the homeowner directly in installments for a set period, usually five to 10 years. Then, you make a balloon payment at the end of the repayment term to cover the remaining balance.
Generally, you can close faster on a seller financing deal than a traditional mortgage, which can help you if you need housing urgently. However, you may have to pay a higher interest rate and make a larger down payment.
In addition, the flexibility of the arrangement comes at a cost. Seller financing deals are subject to fewer regulations than regular mortgages, so entering into one can be risky. Be sure to have your contract carefully reviewed by a real estate attorney.
A rent-back agreement lets you tap into your home’s equity and remain in your house for a short time after you sell it (usually up to 60 days). During this period, you’ll pay the homebuyer rent while you look for or close on a new place to live. If you go this route, have a real estate lawyer draft a formal agreement for the arrangement.
Home Equity Investment
A Home Equity Investment (HEI) is a long-term partnership with an investor who gives you a lump sum in exchange for a portion of your property’s future appreciation. You can use the funds to pay for your next home purchase or renovation project.
With an HEI, you retain ownership of the property. Unlike a traditional loan, there are no monthly payments.
An HEI is also much easier to qualify for than other home equity-related financial products. If your credit score is 500 or better, you live in a zip code where the product is offered, and you have sufficient equity in your property, an HEI may be a viable option for you.
If you need to close on a new home before your current residence sells, an HEI might be the right solution for you. We’re here to help you understand your options, so contact us today or get prequalified for a Point HEI.