Bridge Loan
A bridge loan is commonly known as a short term loan that a borrower takes out against their current property to finance the purchase of a new property.
Also known as a swing loan, gap financing, or interim financing, a bridge loan is typically a short term loan for a six month period, but can extend up to 12 months, with high interest rates and closing costs. Most bridge loans carry an interest rate roughly 2% above the average fixed product.
Most bridge loans are opened when a family is looking to upgrade to a bigger home, and haven’t yet sold their current home, or if a corporation is looking for some positive cash flow.
The bridge loan essentially “bridges the gap” between the time their old property is sold, and new property is purchased. When a seller won’t accept the buyer’s contingency, a bridge loan might be the next best way to finance the new home.
Many purchase contracts have contingencies which allow the buyer to only agree to the terms if certain actions occur. For example, a buyer may not have to go through the purchase of the new home they are in contract for unless they sell their old home first. This gives the buyer protection in the case that no one buys their home, or if nobody is willing to buy the property at the terms they desire.
A bridge loan can be structured so it completely pays off the existing liens on the current property, or as a second loan on top of the existing liens. In the first case, the bridge loan pays off all existing liens, and uses the excess as down payment for the new home. In the latter example, the bridge loan is opened as a second or third mortgage, and is used just as the down payment for the new property.
If you choose the first option, you likely won’t make monthly payments on your bridge loan, but instead you’ll make mortgage payments on your new home. And once your old house sells, you’ll use the proceeds to pay off the bridge loan and all the associated interest and remaining balance.
If you choose the second option, you’ll effectively pay your old mortgage and the mortgage on your new property, which can stretch even the most well-off homeowner’s budget. So make sure you’re able to take on such payments for up to a year if necessary.
Most consumers don’t use bridge loans because they aren’t necessary during housing booms and hot markets. If your house is put on the market and sold within a month, it’s usually not necessary to finance a bridge loan. But now that things are cooling off, they may become a bit more common as sellers have increased difficulty in a buyers market.
Many people find bridge loans risky, as the borrower takes on a new loan with a higher interest rate with no guarantee the old property will sell within the allotted time of the bridge loan. However, the borrower usually doesn’t need to pay interest in remaining months if their home is sold before the terms of the bridge loan are complete, but watch out for prepayment penalties that hit you if you pay the loan off too early.
Do research before you plan on selling your home to see what the asking prices are, and how long homes are typically being listed before their ultimately sold. The market may be strong enough so that you don’t need a bridge loan. But if you do, be aware that a home could go unsold for over six months, or longer, so negotiate terms that allow an extension to the bridge loan if necessary.
If you think a bridge loan is right for you, try to work out a deal with one lender that provides your bridge loan and your long-term loan. Usually they’ll give you a better deal, and a safety net as opposed to going with two different banks or lenders.
Also keep in mind that there are other alternatives to a bridge loan such as financing down payments with your 401k, stocks, and other assets. Look at each scenario before signing anything!
