A short-term bridge loan allows homeowners to use the equity in their existing home to help pay for the next place they’re ready to purchase.
But there are pros and cons to using this type of financing. A bridge loan can prove expensive. So can home equity loans. A personal loan might be a good fit.
What Is a Bridge Loan?
A bridge loan, also known as a swing loan or gap financing, is a temporary loan that can help when buying and selling a house at the same time.
Just like a mortgage, home equity loan, or home equity line of credit (HELOC), a bridge loan is secured by the borrower’s current home (meaning a lender could force the sale of the home if the borrower were to default).
But bridge loans are designed to have much shorter terms. Usually the loan is set up to be repaid in a year or less.
First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.
When to Use a Bridge Loan
Most homebuyers probably would prefer to quickly sell the home they’re in, pay off their current mortgage, and bank the down payment for their next purchase long before they reach their new home’s closing date.
Unfortunately, the buying and selling process doesn’t always go as planned, and it sometimes becomes necessary to obtain interim funding.
Common scenarios when homebuyers might consider a bridge loan include the following.
You’re Moving for a New Job, or Downsizing
You can’t always wait for your home to sell before you relocate for work. If the move has to go quickly, you might end up buying a new home before you tie up all the loose ends on the old home.
Or maybe you’ve fallen in love with a smaller home that just hit the market and you must act quickly.
Your Closing Dates Don’t Line Up as Hoped
Even if you’ve sold your current home, the new-home closing might be scheduled days, weeks, or even months afterward. To avoid losing the contract on the new home, you might decide to get interim funding.
You Need Money for a Down Payment
If you need the money you’ll get from selling your current home to make a down payment on your dream home, a bridge loan may make that possible.
You’re in a Competitive Market
If you’re trying to buy in a hot housing market, sellers may turn up their noses at offers that are contingent on the sale of a home. Being able to show that you have a bridge loan in place could help make your offer stronger.
How Bridge Lending Works
Typically, lenders only issue bridge loans to borrowers who will be using the same financial institution to finance the mortgage on their new home.
And even if you qualified for a new mortgage with that lender, you may not automatically get a bridge loan. You can expect your financial institution to scrutinize several factors — including your credit history and debt-to-income ratio — to determine if you’re a good risk to carry that additional debt.
You’ll also have to have enough equity (usually 20%) in your current home to qualify for this type of interim financing. In other words, eligible bridge loan borrowers generally can apply for up to 80% of their loan-to-value ratio.
Lenders typically issue bridge loans in one of these two ways:
• One large loan: Borrowers get enough to pay off their current mortgage plus the money for a down payment for the new home. Then, when they sell their old home, they can pay off the amount they owe.
• Second mortgage: Borrowers obtain a second mortgage to make the down payment on the new home. They keep the first mortgage on their old home in place until they sell it and can pay off both loans.
It’s important to have an exit strategy. Buyers usually use the money from the sale of their current home to pay off the loan. But if the old home doesn’t sell within the designated bridge loan term, they could end up having to make payments on multiple loans.
Bridge Loan Costs
A bridge loan may seem like a good option to homebuyers in a pinch, but the convenience can be costly.
Because these are short-term loans, lenders tend to charge more upfront to make bridge lending worth their while. You can expect to pay closing costs and a gaggle of fees, just as you would with a traditional mortgage. You also could pay an origination fee that’s as much as 3% of the loan value.
Interest rates for bridge loans are generally higher than conventional loan rates.
Bridge Loan Pros and Cons
As with any financial transaction, there are advantages and disadvantages to taking out a bridge loan. Here are some pros and cons borrowers might want to consider.
The main benefit of a bridge loan is the ability to buy a new home without having to wait until you sell your current home. This added flexibility could be a game-changer if you’re in a time crunch.
Another bonus for buyers in a hurry: The application and closing process for a bridge loan is usually faster than for some other types of loans.
Bridge loans aren’t always easy to get. The standards for qualifying tend to be high because the lender is taking on more risk.
Borrowers can expect to pay a higher interest rate, as well as several fees.
Borrowers who don’t have enough equity in their current home may not be eligible for a bridge loan.
The short-term financing aspect of a bridge loan could lead to financial stress. If you buy a new home and then are unable to sell your old home, you could end up having to make payments on more than one loan, including a bridge loan with a high interest rate.
Worst-case scenario, if you can’t make the payments, your lender might be able to foreclose on the home you used to secure the bridge loan.
Bridge Loan Alternatives
If the risks and other downsides of taking out a bridge loan make you uneasy, there are other options that might suit your needs.
Home Equity Loan
A home equity loan is another way to tap into your current home’s value to cover the down payment on your future home. Because home equity loans are typically long term (up to 20 years), the interest rates available, usually fixed, may be lower than they are for a bridge loan. And you’ll have a little more breathing room if it takes a while to sell the old home. Another plus: The approval process usually goes pretty quickly.
You can expect to pay some closing costs on a home equity loan, though, so you may want to factor that into your decision. You also may want to consider the extra costs involved if there’s a prepayment penalty.
Keep in mind, too, that you’ll be using your home as collateral to get this type of loan. And until you sell your original home, unless it’s owned free and clear, you’ll be carrying more than one loan.
Rather than the lump sum of a home equity loan, a HELOC lets you borrow, as needed, up to an approved limit, from the equity you have in your house. The monthly payments are based on how much you actually withdraw. The interest rate is usually variable.
You can expect to pay a lower rate on a HELOC than a bridge loan, and you’ll have more time to pay it off. But there still will be closing costs and other fees. And there may be a prepayment fee, which could cut into your profits if your home sells quickly. (Because your old home will serve as collateral, you’ll be expected to pay off your HELOC when you sell that home.)
Many lenders won’t open a HELOC for a home that is on the market for sale, so it may require advance planning to use this strategy.
401(k) Loan or Withdrawal
If you’ve been stashing away money in a 401(k), it may be tempting to withdraw or borrow the money for a down payment. But most financial experts advise against it.
You may wish to discuss the rules regarding withdrawals and loans with your employer’s HR department or plan administrator. And if you’re working with a financial advisor, that could be another helpful conversation. Besides missing out on the potential investment growth, there can be other drawbacks to tapping those retirement funds.
If you have a decent credit history and a solid income, you may be able to find a personal loan with a competitive fixed interest rate and other terms that are a good fit for your needs.
• You can sometimes find a personal loan without the origination fees and other costs of a bridge loan.
• A personal loan might be suitable rather than a home equity loan or HELOC if you don’t have much equity built up in your home.
• You may be able to avoid a prepayment penalty, so if your home sells quickly, you can pay off the loan without losing any of your profit.
• Personal loans are usually unsecured, so you wouldn’t have to use your home as collateral.
A bridge loan can help homebuyers purchase a new property when they haven’t yet sold their current home. But a bridge loan can be hard to get and expensive.
A personal loan is an alternative worth considering. SoFi offers fixed-rate personal loans of $5,000 to $100,000 with no fees and no prepayment penalty.
And when you need that next mortgage, check out the competitive rates and other advantages of a SoFi Home Loan.
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