If you are buying and selling a house simultaneously while on a budget, you likely have all your fingers and toes crossed that the timing works out just right. But what happens if the perfect house comes on the market, but you still have yet to get any bites on your current one?
In this scenario, a bridge loan can make the math possible. Basically, a bridge loan is a type of short-term financing that can provide immediate cash to fund a down payment or closing costs if, say, you do not yet have the proceeds from the sale of your current home. While this option is a definite asset to have on the table when you are in a tight financial spot, it does have some downsides and risks, though.
How does a bridge loan work?
A bridge loan is a "short-term loan — often less than a year — that can help you quickly buy a new home without relying on the equity from your existing home to make the down payment," said Nerdwallet. So, you might use one to "cover the down payment on the new home or the costs of having two mortgages until your first home sells," or to "pay off your first mortgage while you take out a new one," said Yahoo Finance.
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The assumption is that your current home will sell in the near future, and you'll then use the proceeds from that sale to pay off the bridge loan. Though payment structure can vary, "borrowers typically make interest-only payments during the term and have a balloon payment when it ends," said CNBC Select.
What are the pros and cons of a bridge loan?
Perhaps the biggest advantage of bridge loans is the opportunity they can offer buyers: You can purchase a new home before selling your existing one, without needing to include a potentially deal-breaking sale contingency in your offer. Funding from bridge loans typically comes through "pretty quickly," too. "Depending on your mortgage lender, you can often have your cash within a few weeks," which "allows you to act fast when you find that dream home," said Yahoo Finance.
That said, bridge loans typically have higher interest rates than conventional loans, plus additional fees and closing costs, and the repayment term is short. You may also end up in a spot where you "own two houses — with two mortgage payments — for a bit," said Nerdwallet. Further, if you do not sell your former home "before the loan comes due, you may owe the full amount of the bridge loan on top of your new mortgage payment," which "could lead to financial stress or even default," said the outlet. And with a bridge loan, your home is typically used as collateral.
How can you get a bridge loan?
Alongside the usual income and credit requirements, to get a bridge loan, "most lenders require a homeowner to have at least 20% home equity built up," said Rocket Mortgage. Additionally, "many financial institutions will only extend a bridge loan if you also use them to obtain your new mortgage," said the outlet.
Keep in mind that "not all financial institutions offer bridge loans," said Yahoo Finance. To get one, you may need to look to "local banks, credit unions, online mortgage companies and specialty lenders."
