Bridge Loans: Helping to Finance Your Move
What Is A Bridge Loan?
Bridge loans are temporary mortgages that provide a down payment for a new home before completing the sale of your current residence. Many buyers today would like to sell their current home to provide a down payment on the next one. But timing can be a problem. You can’t always make that happen. Sales fall through, for instance, or the perfect home for you has multiple offers and a seller who wants to close fast. Enter the bridge loan. This can be an effective tool when buying a new home before selling your current one.
How Do Bridge Loans Work?
There are two ways a bridge loan can be structured. The first method is to pay off your old mortgage, and provide additional cash for your new home down payment. For example, your old mortgage is $200,000, you need $50,000 for your new home down payment, and your current property is worth $500,000. You might take a bridge loan and pay it off from the home sale proceeds.
Your bridge loan doesn’t usually require monthly payments. Instead, the interest is added to your loan balance. This is a great benefit if your income isn’t sufficient to pay two mortgages at once. However, there’s a downside: bridge loans are expensive. Bridge loans, whether in St. Louis or anywhere in Missouri, do come with higher fees, and interest rates of about two percent above comparable prime mortgage rates. That makes sense when you think about it. The lender needs to make money on the loan, even though the loan’s lifespan is only a matter of months. So expect higher borrowing costs.
The second scenario is more like a home equity loan. Instead of replacing the existing mortgage on your old home, you take a smaller bridge loan that just covers the $50,000 down payment on the new property. Once you sell your old home, you pay off your old $200,000 mortgage, plus the $50,000 bridge loan (and accrued interest) from the proceeds. It’s a lower-cost option. However, you must be able to continue paying your old mortgage while also making payments on your new property.
Bridge Loans And Your New Loan Approval
How does the existence of a bridge loan affect qualifying for your new mortgage? Typically, the bridge loan cannot be secured in any way by the new home (this is called cross-collateralization). In other words, the loan has to be attached to the property you’re exiting.
If you have an unsold house and a bridge loan, Fannie Mae or Freddie Mac simply require your lender to “document the borrower’s ability to successfully carry the payments for the new home, the current home, the bridge loan, and other obligations.”
Fannie Mae will not require the old home’s payment to be counted against you in the qualification process. However, the former property must be in escrow and you will submit to the lender the following items.
- The executed sales contract for the current residence
- Confirmation that any financing contingencies have been cleared
If at all possible, provide adequate documentation, so the lender can disregard the payment on the former home.
What If The House Doesn’t Sell?
Bridge loans are designed to be paid off quickly, with normal terms ranging from 6 to 12 months. If you don’t sell your home in time to repay the bridge loan, your program may allow an extension.
However, if your lender doesn’t grant it, or if you get an extension and still can’t sell your property, the lender may foreclose. That’s pretty risky in some markets that are beginning to cool. It’s smart to consider some cheaper and safer options.
Bridge Loan Alternatives
There are other ways to finance a new home purchase before the old one sells. They come with advantages and disadvantages in comparison to bridge loans.
Home equity loan (line of credit)
You might be wondering why you can’t take out a home equity loan against your current property, use it for your down payment, and pay it off when the house sells.
Most lenders won’t approve a loan secured by property that’s listed for sale. That fact will almost certainly be noted on the appraisal.
Home equity loans are meant to be kept for years, not months. Lenders don’t want to spend time and money opening up a line of credit that will be paid off months later.
However, you might be able to borrow against your home equity before putting your home on the market. Plan ahead if you are considering a move in the next year.
Save the home equity proceeds somewhere safe while house hunting, and you’ll have your down payment when you need it.
Make sure the home equity loan does not jeopardize your new home purchase. The home equity payment will be included in your debt-to-income ratio (DTI) when you apply for your new home mortgage.
Your qualifying income will have to support three loans – the old mortgage, the home equity loan, and the new mortgage. Plan accordingly.
Cash-out refinance
This method is probably the closest you can get to a “real” bridge loan. Here’s how to make it work:
- If your home doesn’t sell quickly, refinance it before you put it on the market
- Get a loan with the lowest interest rate, such as a 5-year ARM
- Request a large enough loan amount
Your loan amount should be enough to pay off your current loan, pull cash out for the down payment on the next house, and make several months of mortgage payments.
It’s not exactly like having a bridge loan with no payments, but it’s less expensive and gets the job done.
The lender for your new house will consider both payments when underwriting your loan. Your income will still have to support both payments.
Personal loan
If your credit is good enough, you may be able to borrow your down payment with a personal loan, and repay it when your old home sells.
The costs are generally low, although interest rates for unsecured personal loans are considerably higher than mortgage rates. You’ll still be making payments on three loans until your home sells, however.
401(k) loan
A loan against your 401(k) is an option if your employer allows it. It won’t affect qualifying for your new mortgage because payments are not required (in effect, you’re borrowing from yourself).
If you can repay it (usually within 60 days), you won’t likely incur tax penalties. However, if you don’t get it repaid in time, the amount is taxed as ordinary income, and you will be subject to a ten percent penalty.
Piggyback mortgages
Another strategy is to reduce the required down payment on the new home, thereby eliminating the need for a bridge.
That can be done with a piggyback mortgage on the new home — a first and second mortgage combination. Piggybacks come in several guises — an 80-10-10, for instance, provides an 80 percent first and a ten percent second, then you make a ten percent down payment.
An 80-15-5 requires just five percent down. An 80-20 requires no down payment, although those are nearly non-existent in today’s market.
When you sell the old home, you just pay off the second mortgage on the new property. You’re left with a first mortgage only, at a low fixed rate.
No- and low-down-payment loans
Other options for your new home purchase include USDA home loans or VA mortgages, which require no down payment. Conventional loans go up to 97 percent financing.
These low down payment loans, however, often come with restrictions about the buyer’s current property ownership. Typically, the buyer can’t own adequate housing in the same region, even if there’s legitimate reason to move.
The main drawback for all these methods is that you’re still paying two or more loans until the old house sells.
The biggest advantage of a bridge loan is that it can allow you to buy a new home without obligating yourself to two mortgage payments at once.
If you can swing both payments, there are cheaper, less risky methods of financing your purchase.
Posted by: Carlson Mortgage – a top-rated St. Louis mortgage broker providing home loans in the state of Missouri. We are routinely ranked as a #1 mortgage broker in Missouri on Yelp, Google and Zillow. We can be reached at (314) 329-7314 seven days a week.
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