The decision to buy your next home first or to sell your current home is nearly always complicated. The ideal situation, closing on each transaction on the same day, can be difficult to accomplish. Some buyers have plenty of cash to make a down payment on one property without selling their current home, but for those who do not have that advantage, a bridge loan is a possible solution.
A bridge loan is a short-term loan, often secured by the equity in the borrower’s old home and the new home, says Andrew Batson, president of Found It, a division of Cherry Creek Holdings in Longmont, Colo.
“In today’s seller’s market, home buyers need all the help they can get,” says Steven Yegher, a mortgage loan consultant with Heritage Financial in Annapolis. “The bridge loan is appealing to both the buyer and seller because it eliminates the home sale contingency. A bridge loan also helps the buyer negotiate the best terms because their offer can be perceived as equally strong compared to another buyer who has accumulated liquid funds.”
Sellers in this market, which has so few homes for sale, often receive multiple offers, and few would consider an offer contingent on the buyer selling their current home, Batson says.
While a bridge loan can be a solution for buyers who are more concerned about finding a place to buy than selling their home, the loans are not available from all lenders. In addition, borrowers must meet high standards to qualify.
“Mortgage lenders typically don’t offer bridge loans because government-backed agencies don’t offer them, so they’re more likely found in credit unions and banks,” Batson says.
To qualify for a bridge loan, borrowers must meet the required debt-to-income ratio, which compares their minimum monthly payments on all recurring debt with their gross monthly household income.
“When borrowers take out a bridge loan, their monthly debt includes the mortgage loan on the new property, the mortgage loan on the exit property, the bridge loan secured by the exit property and all other buyer debts,” Yegher says. “Lenders will exclude the debt from the bridge loan once a buyer provides a copy of a ratified contract on their exit property along with their buyer’s mortgage loan commitment letter.”
Pros and cons
The main advantage of a bridge loan is that it allows buyers to purchase their next home without needing to close on the sale of their current home. If they sold their home first, they run the risk of being unable to find a property to buy in this tight market and might need to rent temporary housing while searching for their next home.
“There are some disadvantages to a bridge loan,” Yegher says. “A buyer’s income must be strong enough to carry the mortgage debt on two properties and other consumer debts. There must be enough equity in the exit property to meet the combined loan-to-value requirements of the bridge loan lender, usually a maximum of 80 percent of the home value.”
Bridge loans are short-term loans, usually six months with an option to extend the loan for another six months, Yegher says.
“If the property does not sell in 12 months, the homeowner would need to find some way to dispose of the property and dispose of the mortgage liens associated with the property,” Yegher says.
One other potential issue is that once the buyer moves into the new primary residence, the exit property becomes a vacant property and would need to be managed to mitigate the risk that comes with owning a vacant property, he says.
“A big disadvantage of a bridge loan is that it has higher interest rates and fees,” Batson says. “For this reason, well-qualified buyers may simply choose to take out a second mortgage, such as a home-equity loan or line of credit on their old home and use the proceeds as the down payment on the new home. As long as their income is sufficient to cover both properties, they’ll have both lower costs and rates.”
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