Buying your second home is nothing like buying your first. This time around, you’re coming to the table with the experience of being a homeowner. You know what to expect throughout the buying process, you know what to look for in a home and you know what you can afford. After all, experience is truly the best teacher.
Another major difference this time around is that you’re likely counting on proceeds from the sale of your first home to help cover the down payment and the closing costs of your new home.
But what happens if selling that home is taking a bit longer than you’d anticipated? What if you need to move immediately because of a job opportunity, or because there’s a great home on the market that will be snatched up if you don’t grab it quickly? How are you going to come up with the funds if your own home isn’t selling quickly?
This is where bridge loans come in. A bridge loan provides temporary financing until more permanent financing can be obtained. When taking out a bridge loan, it’s understood that once permanent financing is in place, some of those funds will be used to pay back the bridge loan. Bridge loans are most commonly used to help the borrower span the gap between the sale of one home and the purchase of another.
Terms vary tremendously, so take the time to talk with your loan officer. Some will completely pay up the outstanding mortgage on the old home, while others will only pay off a portion of it, leaving the borrower with two mortgages, or simply lumping the loans together.
Bridge loans understandably have shorter terms than other loans, and are typically more expensive as well. Also, a lender will usually only extend a bridge loan if the borrower agrees to finance their new home’s mortgage through the same institution.
Bridge loans seem to provide the ideal solution to a less-than-ideal situation: You can now house-hunt freely and without waiting for your current home to sell. However, bridge loans are not as simple as they may seem.
Let’s take a look at some of the pros and cons of taking out a bridge loan.
1.) Freedom to house-hunt
The most obvious benefit of taking out a bridge loan is also the most significant. With this financing in place, you’ll be free to buy the home of your choice, without being bound by the sale of your previous home.
2.) Short lending term
Another big benefit of bridge loans is their short lifespan. Bridge loans usually run for six-month terms, though they can span anywhere from several weeks to several years. In contrast, most conventional loans are structured around a long payback term that can last for decades. The longer the payback term, the more likely it is that the borrower will suffer from a financial setback, which makes repayment challenging or impossible.
This, in turn, can give rise to further financial challenges as the borrower is hit with various penalties and fees, or is forced to take out another loan. The short payback term of bridge loans assures that this loan will not be a source of financial stress for years to come.
1.) Total debt increases
Any loan a buyer takes out will cause their total debt to climb. Sometimes, a bridge loan will split the purchase of the second home into two mortgages, leaving a buyer with three monthly mortgage payments; one from their previous home, and two from their new one. Other times, the buyer will be left with two mortgages to pay, which can also be a strain on their budget. In either case, an increase in debt means an increase in monthly financial obligations.
2.) High interest rates and fees
To compensate for their short lifespans and the amount of work the lender has to do for them, bridge loans generally have high interest rates, generally reaching between 8.5 – 10.5% of the total loan. There are also various fees involved, such as closing costs, origination fees and more.
3.) Risky contingency
Bridge loans are usually taken out with the understanding that the sale of your existing home will allow you to repay the loan. But what if your house doesn’t sell before the loan is due? This can happen even if you have an interested buyer – they may not get the financing they need or they may back out. This will leave you with a huge debt on your hands that you can’t afford to repay.
It’s important to speak to a Realtor about market conditions before taking out a bridge loan, even if you think you have a buyer. Make sure the odds are in your favor and that it is likely your home will be sold on time before committing to a loan that is contingent on its sale.
If you really need the funds from the sale of your home before the transaction is finalized, but the thought of taking out a bridge loan makes you uneasy, you may want to consider other options. You can take out a HELOC, borrow against a 401(k) plan or take out a loan secured by stocks, bonds or other assets.
And of course, don’t forget to call, click, or stop by Destinations Credit Union for guidance throughout the process of buying and selling a home.
Your Turn: Have you bought a second home recently? How was the purchase different than your first time around? Share your experience with us in the comments!
One thought on “The Pros And Cons Of Bridge Loans”
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