How Do Bridge Loans for Home Mortgages Work?
Buying a home when you have one to sell first can be risky. If you did not place a contingency clause in your purchase contract, you may be stuck with buying the house whether or not you have closed the sale on your existing property. If this happens to you, there is an option that makes it possible for you to come up with the down payment and continue with the purchase before you sell your home. Bridge loans in real estate exist for this purpose, but, before you apply, you should have all of the information necessary to make an informed decision.
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Pay Off Existing Mortgage
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One type of bridge loan pays off your existing mortgage so that you can use the excess money that you receive to buy your new home. Normally, you make payments on your new mortgage only. If the house doesn't sell within a specified period of time, such as six months, you may be required to make interest payments on your bridge loan. You will pay off the bridge loan plus all accrued interest charges when you close on the sale of your old property.
Equity Loan
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Bridge loans on real estate may come in the form of an equity loan. In this case, you will borrow a percentage of your existing equity, which is the difference between the market value and amount of loans that you have on your house. However, some lenders may allow you to borrow only up to 75 or 80 percent of your equity to use as a down payment on your new home. In this case, you will continue to pay the mortgage on your first property in addition to the new one. When you sell your property, you will pay off your first mortgage and the bridge loan.
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Pros and Cons
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A bridge loan allows you to move into your new property sooner. This may be vital if you are relocating to take a new job or if you have found a property that will be less expensive for you in the long run. However, you should be aware of the risk associated with these loans. Closing costs and fees to obtain the loan may be high. Some may come with prepayment penalties, so that, when you are ready to pay it off, you may have to wait or be charged a large fee to do so. The interest rate traditionally is as much as 2 percent higher than a conventional mortgage, according to CityTownInfo.com. If your house does not sell during the terms of your bridge loan, you can be stuck with exorbitant payments for both homes combined. Also, you may be required to pay it off after a short time, such as 12 to 36 months.
Considerations
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It's tough to predict the real estate market, and if your home doesn't sell during the terms of your bridge loan, you may need to drop the price. This may not give you enough to pay off your loan once the house closes. Therefore, ensure that there is a clause in your loan documents that allows you to extend it with the same terms, if necessary.
Instead of a bridge loan, consider using funds from certificates of deposit, a 401k account or a whole-life insurance policy. There may be tax and other penalties associated with liquidating these accounts, so check with a certified public accountant before deciding the avenue that's best for you.
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