A bridge loan is a short-term loan used to bridge the gap between buying a home and selling your previous one. It can be used to make a down payment on a new home when you need extra cash before you’ve completed the sale of your current home. In this guide, we’ll cover how bridge loans work and the pros and cons to help you determine if they’re a good fit for your situation.
How does a bridge loan work?
A bridge loan works similarly to a mortgage. The lender qualifies you based on a review of your income, assets, and credit and requires an appraisal to determine the value of your home.
You will decide whether the loan is a first or second mortgage. Here’s how each works:
- First-mortgage bridge loan: This covers the balance of your mortgage, plus enough to cover a down payment. Your current mortgage is paid off, and the bridge loan takes first position until you sell your current home, at which point you pay it off.
- Second-mortgage bridge loan: This covers the amount you need for a down payment on your new home. The loan is secured by your current home, which makes it a second mortgage.
You’ll typically be able to borrow up to 75% of your home’s value, and you may have options for how you make your monthly payment.
The pros and cons of bridge loans
In this section, we’ll break down the pros and cons of bridge loan financing for homebuyers.
- Using current home equity to buy a new home without selling it right away.
- Maintaining some savings.
- Make offers without contingencies for the sale of your current home.
- You may be able to make interest-only payments
- Make a larger down payment on the new home purchase.
- You’ll likely pay high interest rates and closing costs.
- You could potentially have three monthly mortgage payments for a certain period of time.
- There is a risk of losing both homes if you can’t make payments and the lender forecloses.
- The loan will be considered riskier and have fewer federal protections.
- It can be difficult to find a bridge lender.
When do you need a bridge loan?
Here are some of the situations where a bridge loan makes the most sense:
- Purchasing a new home in a highly competitive market
- Buying a fixer-upper that needs significant repairs
- A short-term, fix-and-flip home purchase
How to find bridge loan lenders and alternatives
Bridge loans are a special product that not all lenders will offer. Reach out to your current lender, local banks and credit unions, non-qualified mortgage lenders, and hard-money lenders. If you’re having trouble finding a lender or you’re looking for bridge loan alternatives, consider these options:
Home equity line of credit – This product works like a credit card and allows you to borrow as much as you need up to your credit line’s limit. Your home is used as collateral, similarly to a bridge loan.
Home equity loan – With this alternative, you borrow against a percentage of your home’s equity as a lump sum that you begin paying right away. Your current home secures the mortgage.
Cash-out refinance – This option replaces your current loan with a larger mortgage and uses the difference for a down payment for the new home purchase.
80-10-10 piggyback loan – You take out two loans on the new home and make a 10% down payment: one for 80% of your home’s value and the other for 10%. When your current home sells, you can pay off the rest and are left with only one mortgage payment.
A bridge loan can come in handy in circumstances where you need to buy a new home before an old one has sold. However, keep in mind it can lead to a costly acquisition and add to your overall debt load. The best strategy is to wait to sell your old house before moving forward to acquire a new property.
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