Crossing the Gap from this Home to the Next: Bridge Loan
Written by: Cameron Brown
So you're thinking of getting into a bigger house. You call up the real estate agent and make an appointment to go see what the market has to offer. Then you find it, the perfect "move-up" home. It's everything you've ever wanted in a home unless your married, in which case it's everything your wife has ever wanted in a home.
You'd make an offer right then and there but realize you need to sell your old home before you can by this one. You haven't even put your old house on the market yet. What to do?
The real estate agent advises that you could make what's called a "contingent offer"; buying the new house is 'contingent' on you selling the old one.
"Oops", says the agent, "Your old home isn't even listed yet? You may have wanted to do that before we went house hunting. Your offer is a little too 'contingent' for most sellers
they probably won't take it."
But before you give up all hope of getting into the home you want, first consider a bridge loan.
A bridge loan is a form of second trust that is collateralized by your present home in a manner that allows the proceeds to be used for closing on a new house before the old house is sold.
A bridge loan "bridges" the gap between the two transactions and is often the difference between getting the house of your dreams and missing out entirely. Bridge loans can also be setup to completely pay off the old mortgage or to add the new mortgage to your current debt.
Usually people who take out a bridge loan will use the funds to pay off the old mortgage while putting the rest towards the new home's down payment, first deducting any closing costs and prepaid interest.
Typically, the loan is structured with a relatively short term, usually six months to a year, and hefty prepaid interest.
Because of the risk involved in making a loan on collateral with only possible future value (the future sale of the old house), most lenders charge high interest rates on their bridge loans. The borrower typically must begin making these payments after six months if the house still hasn't sold.
Most often, a bridge loan is used to pay off the existing mortgage, with the remainder (minus closing costs and prepaid interest) going toward the down payment on the new home. If after six months the old home has not sold, the borrower begins making interest-only payments on the loan. When the home eventually sells, the bridge loan is paid off; if the house sells with in six months, all unearned interests are credited to the borrower.
In a perfect world you would have your house on the market will potential buyers making offers before you make any offers yourself. However, because of fluctuating market conditions, getting the timing right can be difficult. If you're willing to pay the higher rates and fees that come with a bridge loan you can buy yourself some extra time.
While a bridge loan can get you th e house you want when you want it, it can be a pricey option in the long run. If it's an option for you, it may be a better idea to borrow against assets such as stocks or your 401(k). This can save you a considerable amount of money.
Before you do anything talk to someone who has experience in the financing side of the real estate market. There are more options for borrowers every year and consequently the process gradually gets more complicated. It pays to take the time to understand what you're getting into.