Buying a home can be a challenging process to navigate. Whether it's your first home and you're working hard to come up with a down payment, or whether you're upsizing to something more suitable for your growing family, the journey can be stressful.
On top of crunching the numbers and figuring out what's affordable, housing markets can be tough to work with too. Particularly in hot housing markets, you need to know what you're working with and be able to make decisions quickly.
A common question when it comes to transitioning from one home to another is, "Do I need to sell my current home before I buy a new one?" Many people understandably think, "Of course you do!" The reality is that you don't. In fact, there's a relatively simple way to work around this common dilemma.
Bridge Loans
Enter the concept of bridge loans (also known as a swing loan). Bridge loans are a handy way to navigate those situations where you might need to buy a new home before selling your old home. Arranging closing dates and possession dates perfectly can be difficult to manage, but bridge loan financing is here to help you out.
What Is A Bridge Loan?
A bridge loan (also called bridge financing) is a short term loan that allows you to use the equity of your current home to finance the purchase of your new home. The concept is similar to that of a home equity line of credit (HELOC) except that it is only short term.
Most lenders are willing to finance a bridge loan for anywhere between 3 to 6 months; sometimes even up to 12 months depending on your financial situation. Each application is dealt with on a case-by-case basis and is highly dependent on several important factors.
When Would I Use a Bridge Loan?
The usual process for transitioning between homes is to sell first and then buy a new home. However, there are situations where this ideal arrangement might not happen.
Depending on where you live in the country and depending on the housing market, houses that are for sale can move very quickly. In this type of situation, having a contingency clause around needing to sell your current home can be a disadvantage.
In order to move quickly in that type of housing market, you might need to be okay with buying before selling your home. A bridge loan empowers you to do this efficiently and relatively cost-effectively too.
How Do I Qualify For a Bridge Loan?
Qualifying for a bridge loan is not overly complicated. Financing for a bridge loan is typically dependent on the things you would need for any regular loan: stable income and a good credit score.
Additionally, a decent amount of equity in your current home must be built up in order to qualify for a bridge loan. Most lenders would expect a minimum of 20% equity. Some private lenders may be more flexible depending on income levels.
With these qualifications, all you need is a sale agreement on your current home and a purchase agreement on your new home and you're ready to make it happen.
Calculating Bridge Financing
The math behind bridge loans is not overly complicated. Here's a simple example.
Let's say you find a great deal on a house that's worth $300,000 and you plan to put a 10% down payment on that new home ($30,000). Additionally, you have $140,000 of equity in your current home that you plan to add to the down payment, but that money is tied up in your current home until you sell it after the possession date of your new home.
The possession date of your new home is May 1st, 2021, but the closing date on your current home isn't until May 24th, 2021. You will need a bridge loan to cover that 24 day time period where your equity is tied up in your current home.
The calculation for the bridge loan is quite simple. You take the total amount you are PLANNING to use as your down payment ($140,000) and subtract what you DO use for the initial down payment.
$140,000 - $30,000 = $110,000.
Your bridge loan is $110,000 and that amount is financed over 24 days until the sale of your current home closes.
Additional Fees with Bridge Loans
Lending fees for bridge loans are fairly reasonable especially given that the time period is quite short. Most often the interest rates are Prime + 2-3%. On top of that, lenders usually charge an administrative fee for handling this process. That fee can be anywhere from $200-500.
Overall, this is a fairly reasonable cost for the ease of transitioning between homes when possession dates don't line up optimally.
Potential Pitfalls
As hassle-free as bridge financing sounds, there are some potential pitfalls to watch out for when leveraging this option.
One of the primary concerns with bridge financing is to keep the time period short. Most lenders are willing to lend for up to a 3-6 month time period. This is reasonable and doable for most homeowners. Obviously the longer the time period, the more interest you will pay.
Another potential pitfall is that you may be rushing to sell your home. Perhaps you found a great deal on your next home, but now you need to sell your current home. Depending on the housing market you are in, a quick sale might be a challenge to pull off. In order to achieve that, you may end up sacrificing price on the sale of your home which could affect the equity you are planning to put into your new home.
A further risk is if the timeline of your bridge loan passes and you still have not sold your current home. At this point, you will be left holding two mortgages which is likely uncomfortable for most people regardless of the housing market you are in. This is a worst-case scenario of course, but it's important to be aware of the potential for this.
Is A Bridge Loan Right For You?
Bridge loans are a great way to get you out of that logistical pinch where closing dates don't line up. If you are in a secure financial situation, this can be an easy process to execute with very little headache.
Like most things in life though, there is always a small amount of risk involved. Be sure to consult a professional mortgage broker or financial advisor to assess your situation and evaluate if this is the right move for you.
