bridge mortgage loans

What is a bridge mortgage loan?

A bridge loan is a type of financing used by people who want or need to buy a new home before they have sold their existing residence.

For example, if a job transfer requires somebody to move to another city, he or she could use a bridge loan to buy a house in their new location before they’ve sold their existing house. Bridge loans may also be used by individuals who want a particular house that is on the market, but haven’t been able to sell their existing one ye.

How bridge loans work
A bridge loan can be structured in one of two ways. One method is to use the bridge loan to pay off the current property. In this scenario, the bridge loan pays off all existing liens and any excess funds would be applied to the downpayment on the new home. Once the first house sells, the proceeds will pay off the bridge loan, leaving you with a mortgage on the new residence.

Another is to treat the bridge loan as a second mortgage, similar to if you were buying a vacation home or investment property. In this scenario, the bridge loan is used as a downpayment on the new house, and you’ll essentially be making two mortgage payments until the first home sells.

Bridge loans typically have a six-month to one-year term and are secured by the home the buyers are trying to sell.

Because bridge loans are intended to be short-term, lenders may not have the same requirements as they do with regular mortgage loans. Some lenders will actually exclude the bridge loan payments from the qualifying process.

Furthermore, if the new home mortgage is a conforming loan — meaning it adheres to standards imposed by Fannie Mae and Freddie Mac — lenders can accept a higher debt-to-income ratio for the bridge loan, up to 50 percent.

Even with relaxed lending requirements, many borrowers will not qualify for a bridge loan because they will not have the resources to carry two mortgages. Typically, a lender will only finance 80 percent of the combined value of both properties. If you’re selling a home for $200,000 and trying to buy one for $300,000, you can obtain total financing of $400,000.

In addition to owning two homes simultaneously, having a bridge loan will carry high costs for interest and fees. On average, the interest rate on a bridge loan is a full two percentage points higher than a standard mortgage, and fees can cost more than 1 percent of the outstanding loan balance. Also, lenders seldom grant a bridge loan unless the borrower agrees to finance the new home’s mortgage with the same institution.

Alternatives to bridge loans
Taking out a bridge loan can be risky, especially if the real estate market is such that your existing home may remain for sale for longer than the bridge loan term.

If you are in a situation where you need to move before you can sell your home, there are alternatives to bridge loans, including:

Borrowing against your existing home. If you have enough equity in the home you are trying to sell; you can apply for a home equity loan to make the downpayment on the property you’re trying to buy. You can typically borrow up to 80 percent of the home equity you have available. Since you’re trying to sell the home, losing the home equity won’t matter too much. After all, you are probably going to use the proceeds from the sale of the first home as a down payment for the second home; this arrangement just accelerates the process.

Rent in your new city instead of buying immediately. If you need to move because of a job or other reason, you might want to consider renting in your new city instead of buying right away. This will give you time to sell your existing property.