Investors or residents who want to buy a house usually have to first sell their old house to raise cash for a down payment. However, this can be problematic because of timing. If the new house is a hot item, waiting for the old house to sell can mean missing out on a great deal.
An option is to add a contingency to the purchase. The purchase can only go through if the old house is sold. However, some sellers aren’t going to want to deal with contingencies.
The buyer isn’t completely out of options yet. There is also the bridge loan. We will go over what a bridge is and how it works.
What Is A Bridge Loan?
The main idea behind a bridge loan is that you can buy a second house without having to incur two payments at the same time. This can be useful for someone who wants to buy a house but hasn’t yet sold their first house.
Without a bridge loan, the buyer usually will have a contingency contract. The contract states that they must sell their first house before they are obligated to buy the second house. Some sellers may not allow these contingencies, which can cut down the availability of homes for the buyer.
A bridge loan allows the buyer to make a non-contingent offer. It does this by filling the gap (i.e., bridging) between what the buyer can and can’t afford.
To qualify for a bridge loan, the buyer needs to have equity in their home. Many bridge loans require an 80% LTV (loan-to-value). Meaning the buyer needs at least 20% equity across the two properties.
The buyer can then take the equity in their home and use it to buy the new property.
Once the deal completes, the buyer can refinance out of the bridge loan. The loan is typically for six to twelve months.
Only some will qualify for a bridge loan. They typically have stricter requirements than traditional mortgages, such as higher credit scores.
Some people confuse hard money loans with bridge loans. However, the two are different. A hard money loan doesn’t allow the borrower to take equity out of their property to buy new property.
How Does A Bridge Loan Work?
Let’s look at the details of what happens when a buyer gets a bridge loan.
Below is a simple example to show how a bridge loan works. The value of the two homes is added. Then the LTV of the total is calculated. The old mortgage is subtracted from this amount to determine the bridge loan amount.
$100k: New home
$100k: Old home with $60k mortgage
= $200k: total value of both homes
x 80% (LTV)
= $160k
- $60k (old mortgage)
= $100k: bridge loan
Some lenders let the buyer defer payments on the new mortgage until the bridge loan is paid. Interest-only payments are common. If no payments are made, then interest simply accrues.
If the old home isn’t selling, at some point, the buyer will have two loans as the bridge loan comes due. So while a bridge sounds like a great alternative to a non-contingent deal, things can go wrong.
Bridge loans often have higher fees than mortgages and HELOCs.
Anyone considering using a bridge should be aware of the fees. Any of the following can be included: closing costs, origination costs, and refinancing fees at the end. Generally, these fees are quite prohibitive. However, when left with no options, a bridge loan can provide the opportunity to take advantage of a great offer.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Hypothetical examples shown are for illustrative purposes only.
