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What is a Bridge Loan?

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Being in a transitional stage when it comes to simultaneously selling and buying real estate does not have to be financially crippling. A bridge loan can help you.

What are bridge loans?

A bridge loan is a loan a temporary short-term loan you can apply for to help you afford to move while you are in the process of selling your current home. For example, if you are in a starter home and need to upgrade because your family has expanded, you may not have enough money saved to afford a down payment on a new home. This is where a bridge loan comes into play. You can be approved of a loan to make a 20% down payment on your new home.

Bridge loans can also be referred to as gap financing, swing loans and interim financing. The loan bridges the gap between selling your current home and purchasing a new home. Bridge loans are popular during a slow market.During a hot housing market, bridge loans are unnecessary, because most homes sell quickly.

Types of Bridge Loans

There are two different types of bridge loans a borrower can acquire. The first type of bridge loan consists of enough money to pay off your old mortgage plus money to pay for a down payment on your new home. You do not have to pay mortgage payments on your old home or payments on your bridge loan, but you will have to make mortgage payments on your new home. Dependent upon you lender, you may borrow up to 80% of the combine value of both homes.

The second type of bridge loan borrows against the equity in your old home. This is similar to a home equity line of credit. The equity can used for a down payment on your new home. With this type of loan, you will still have to make payments on your old mortgage, because you have not borrowed enough to pay it off. Therefore, you may be stuck with paying two mortgages at once and the bridge loan. In this case, the bridge loan acts as a third mortgage.

How long is a bridge loan?

Bridge loans are temporary in nature. The lender sets up the due date.This loan is good for six months, but it can be extended to 12 months. Most people pay off the loan right after their current home sells. The first type of bridge loan requires that you pay your principal balance and any accrued interest. The second type requires that you pay back the equity. When you sell the home, you will then pay off the rest of your old home’s mortgage.

What are interest rates of a bridge loan?

Most bridge loans have an interest rate of 2% above a normal 30 year fixed-rate mortgage. The fees can be very costly. Here is an example of 8.5% bridge loan that comes with four months of no payments. However, during the four months, interest will accrue.

Administration fee: $750

Appraisal fee: $375

Escrow fee: $350

Title policy fee: $350+

Notary fee: $40

Recording fee: $65

Wire/courier/drawing fee: $75

Plus, the initial amount times the interest rate.

Are bridge loans risky?

Most people are wary of bridge loans, because they are risky in nature. During a slow housing market, there is no guarantee your home will sell. If your home does not sell, you may be stuck with two mortgages and a loan payment. Since bridge loans are temporary, the principal may be due when you have no money to pay it.

Your lender may be lenient on the payments. They have the authority to set the loan rules and the terms of the repayment.Some lenders do offer an extension of a bridge loan if your home does not sell within the first six months.

If your home sells fast, you can avoid paying interest for the remaining months of the bridge loan. You have to make sure your lender does not have any prepayment penalties. It may be less expensive to pay interest than to pay prepayment penalties.

Research can help you understand the current housing market in your area. Before you apply for a bridge loan, look at what is selling in your area. What are the asking prices? What are the characteristics of the homes that sell? Are they updated and remodeled? Because if your home needs upgrading, it may be best if you apply for a bridge loan that is a little more than you need to pay for upgrades to your old home. This can help your home sell faster and decrease the risk of your home not selling.

One of the best ways to go is to use a single lender for the mortgage of your new home and the bridge loan. They are usually more willing to work with you and give you a better deal opposed to having a long-term mortgage at one mortgage company or bank and a bridge loan at another lender.

What are the cons of bridge loans?

The closing costs are higher than other loans such as a straight home equity loan.
Most lenders require the burrower to own two homes or be in the process of purchasing a new home to be qualified for the loan.

Bridge loans can cause financial strain on you. If you get the second type of bridge loan, you have to pay two mortgages and accruing interest on your loan. That can be very difficult.

Alternatives to Bridge Loans

Home Equity Loan

Equity is the difference between the remainder of your mortgage and the appraised value of your home. A home equity loan is when you get a loan for that difference amount. This is a common alternative to bridge loans. The catch is that you have to acquire a home equity loan before you put your old home up for sell.

Borrow Money

You can get a loan from your bank or another lender for the amount of the down payment. You can also borrow from your 401k in order to afford a down payment on your new home. You can also borrow against other assets such as a boat, a savings account, etc.

(Photo by Joe Raedle/Getty Images)

Written by Mike Chace

Real estate junkie interested in interior and exterior design, home improvement, DYI projects, and landscaping.