Thanks, in part, to increased interest rates, the housing market has cooled off recently; but that doesn’t mean it is any less competitive for prospective home buyers with their eyes on the same homes in the same neighborhoods. There are generally two types of offers when it comes to buying a house: cash offers and contingent offers. Cash offers are by far the most appealing to sellers, since there are no obstacles (such as the sale of a previous home) that could prevent the final sale. So how do you avoid losing out to cash offers if your only means of financing is the equity from the sale of your former home? Well, you could consider a bridge loan to buy your next house while you await the final sale of your old one.
What is a Bridge Loan?
A bridge loan, also called a “swing loan,” is a short-term loan designed to bridge the gap between a purchase and longer-term financing. In the case of home ownership, this type of loan allows you to borrow against the equity in your current home (before it sells) in order to purchase or make a down payment on your next property. In some cases, you can also borrow against the overall value of your current home. In other words, you will be able to make a cash offer to a seller as opposed to a contingent offer that relies on the successful sale of your former home.
Bridge Loan vs Equity Loan to Buy a House
While both a bridge loan and an equity loan use your current home as collateral, the terms are very different. A bridge loan usually entails that you are trying to sell your home and will need to be paid off as soon as the sale is complete. The terms are generally between 3 and 6 months, and interest rates are between 8.5 and 10.5 percent. Bridge loans are typically used as a down payment for a new home, but they may also be used for moving expenses while you await your closing sum.
A home equity loan, on the other hand, is given before you intend to sell your home and it can be used for a variety of needs, including moving expenses and a down payment on a new home. The interest rates are slightly lower (between 5-6 percent), and you have a much longer period of time to pay this loan off (up to 20 years, in some cases).
How Do Bridge Loans Work?
Bridge loans are typically applied in two ways: 1) you can use one to pay off your current mortgage and use the remainder as a down payment on a new home; 2) as a second mortgage. Let’s see how these two scenarios would work with specific numbers. In each case, you will be limited to 80 percent or less of the loan-to-value (LTV) ratio. In other words, you can only borrow up to 80 percent of what your home is worth or its equity amount.
Bridge Loans as a Down Payment
This type of bridge loan uses a percentage of the home’s value. For example, if your home is worth $400,000 and you apply for a bridge loan that is 70% of that value, you would receive $280,000. If you have $200,000 left on your current mortgage, you could use this amount to pay off that mortgage and then put the remaining $80,000 toward a down payment.
Bridge Loans as a Second Mortgage
This version of a bridge loan uses a percentage of your home’s equity. For example, say your current mortgage loan is 300,000 and your home value is estimated at $400,000. This means you have $100,000 in equity. If you apply for a bridge loan of 70 percent equity, you would then have $70,000 as a down payment for your new home while you wait for your old home to close. At that point, you would pay off the bridge loan with the proceeds of your home sale and use the remainder to secure a new mortgage.
When is a Bridge Loan a Good Idea to Buy a House?
In the case of buying a home, a bridge loan can be useful in the following scenarios:
- The area you are buying in prioritizes cash offers over contingent offers
- The closing date for the sale of your old home is after the closing date for your new one
- You need funds to finance moving costs while waiting for the sale of your old home
- You cannot afford enough of a down payment before the final sale of your old home
Again, the main benefit of a bridge loan is that it gives you an edge in a seller’s market, where homes are often sold to those with cash on hand and who will not be able to back out of a contract because a sale failed to go through.
How To Qualify for A Bridge Loan
Bridge loans can be riskier for lenders since they rely on the sale of your home as collateral. Should the home fail to sell or sell for a far lower price, they would potentially lose out on their initial investment. To mitigate this risk, bridge loans often come with certain fees and higher interest rates.
You will also need a good credit score and reasonable debt to income ratio. These stipulations will often vary from lender to lender, so it will be worth it to shop around a bit if you are in need of a bridge loan. The best place to start is locally, with a lender who has built a reputation within the community. “Fast cash” lenders that are national tend to charge even higher interest rates and will not have the same resources as someone who is local to the area.
Pinetree Financial Partners offers bridge loans for a wide variety of projects in Colorado. We are passionate about working with clients to find the perfect financing solution to make their dreams come true. Contact our office today to schedule a consultation and get started.