If the housing market has slowed and you want to buy a new house but you’re not sure you can sell your current house before the 30-day close, you may benefit from a bridge loan. Bridge loans can help “bridge” the gap in funding in between buying a new home and selling your old one.
A bridge loan is a temporary, short-term mortgage loan that uses your existing home as collateral and allows you to pay for the new mortgage while still paying for the old mortgage. They are also known as gap financing, interim financing or swing loans. They are commonly used when buyers want to upgrade to a new home but haven’t yet sold their current home.
A bridge loan can be structured either as a new mortgage that pays off your existing loan and provides extra money for a down payment on your new home or it can act like a second mortgage, giving you just enough for a down payment on the new property. Either type usually allows for a six-month repayment period but can often be extended up to 12 months.
The total amount to be borrowed is typically 80% of the sum of your current property plus the one you want to buy. For example, your existing home is worth $200,000 and you want to buy one priced at $275,000. You could potentially qualify for a bridge loan as high as ($200,000 +$275,000= $475,000 x 0.8=) $380,000.
The bridge loan and its interest fees are usually repaid from the sale of the current home. However, if it takes longer than expected to sell, you may have to begin making payments after a few months. In other cases, the bridge loan is repaid as one large balloon payment at the end of the loan term.
The lending requirements for bridge loans are not as well defined as for traditional mortgage loans, but in general borrowers will need to have substantial equity in their current home to qualify. Many lenders require at least 20% equity. You may not need a specified credit score, but the lower your score, the higher your interest rates will be. Lenders will also look at how much debt you have compared to how much you earn. If you are looking to take out a jumbo loan, lenders may only allow up to a 50% debt-to-income ratio.
Bridge loans can be a helpful tool when you need to buy a new home before you sell your current place. Because they carry significant risk, be sure to carefully make a plan for selling your existing home in a timely manner and consider other possible mortgage financing solutions.