They can save the day for homebuyers in a pinch, but people looking for a “bridge loan” to span the gap between the sale of an old home and the purchase of a new one should ask if the cost is worth it.
Experts say it almost never is, and people would be better off staying put until they’ve unloaded their first residence. If that’s impossible, they warn, be prepared to shoulder a heavy burden.
“There are many sad stories about homeowners who took bridge loans, and our best advice would be, ‘Don’t do it,'” says Richard Roll, president of the American Homeowners Association in Stamford, Connecticut. “You can find yourself in a totally untenable position, and you can lose your first house.”
What is a bridge loan?
A bridge loan is a short-term loan designed to provide financing during a transitionary period – as in moving from one house to another. Homeowners faced with sudden transitions, such as having to relocate for work, might prefer bridge loans to more traditional mortgages.
Bridge loans aren’t a substitute for a mortgage. They’re typically used to purchase a new home before selling your current home. Each loan is short-term, designed to be repaid within 6 months to three years. And like mortgages, home equity loans, and HELOCs, bridge loans are secured by your current home as collateral.
Terms can vary widely
A tool used by movers in a bind, bridge loans vary widely in their terms, costs and conditions. Some are structured so they completely pay off the old home’s first mortgage at the bridge loan’s closing, while others pile the new debt on top of the old. Borrowers also may encounter loans that deal differently with interest. Some carry monthly payments, while others require either upfront or end-of-the-term lump-sum interest payments.
Most share a handful of general characteristics, though. They usually run for six-month terms and are secured by the borrower’s old home. A lender also seldom extends a bridge loan unless the borrower agrees to finance the new home’s mortgage with the same institution. As for rates, they accrue interest at anywhere from the prime rate to prime plus 2 percent.
One Norwest Corp. bridge loan, for example, would total $70,000 on a customer’s old $100,000 home with $50,000 in mortgage debt outstanding, says Patty Stubbs, branch operations supervisor for the company’s Des Moines, Iowa, mortgage division. Of that, $50,000 would go toward the old house’s lien and a few thousand would cover the bridge loan’s closing costs, origination charges and fees, leaving the customer with about $16,000 for the new home’s down payment, closing costs and fees.
This example helps to show how the high fees associated with bridge loans can cause problems. Norwest’s customer, for example, would end up paying between $2,000 and $3,000 for closing on the bridge loan, 1.5 percent to 2 percent of its value for an origination fee, and another couple thousand dollars for closing on the new home’s mortgage.
What if the sale goes sour?
Real estate market risks can exacerbate the danger, Roll says. For example, Norwest and others are usually willing to extend bridge loans slightly beyond the standard six months. But what happens to a homeowner who gets the financing and extension, so the old home’s buyer can have a little more time, only to see the transaction fall through?
“Let’s say they need some of that money to buy their new house, so it’s predicated on selling their old house,” Roll says. “What happens if they don’t sell that house, or if the buyer doesn’t get financing?”
In such a case, the lender could go as far as to foreclose on the old property after the bridge loan extensions expired, Stubbs says, or a customer could deed the property to the bank, which would sell it and apply the proceeds toward paying off the loan.
Consider other options
For those trying to stay away from bridge financing, borrowing against a 401(k) plan or taking out loans secured by stocks, bonds or other assets are options, says Kevin Hughes, a mortgage loan specialist at Cambridgeport Bank, based in Cambridge, Massachusetts. Some lenders also offer hybrid mortgage products that behave similarly to bridge loans.
For example, a Cambridgeport customer with $50,000 equity on a $100,000 home, for example, could obtain a combination first and second mortgage on a second $100,000 home, Hughes says. Only one set of closing costs of about $1,300 would be required, with about $184 in additional costs for the second mortgage.
As part of the bank’s program, that person would make a $10,000 down payment on the new property, which would have both a first mortgage for $50,000 and a second for $40,000. Upon selling the old home, the borrower could use the $50,000 worth of equity to simultaneously pay off the new home’s second mortgage and recoup the money that covered the down payment.
Bridge loans vs. home equity loans
Home equity loans are one of the most popular alternatives to bridge loans. Like a bridge loan, they are secured loans using your current home as collateral. But that’s where the similarities end.
Home equity loans borrow against available equity in your home. They are usually long-term loans, and repayment periods can be anywhere from 5 to 20 years. If you qualify, interest rates tend to be more favorable with home equity loans than with bridge loans.
But using a home equity loan to finance part of a new home purchase, such as the down payment, can still be risky. If your original home fails to sell, you may find yourself paying three loans: your original mortgage, your new mortgage, and the home equity loan. We still recommend waiting until a deal closes on your original property. But if you’ve built up sufficient equity in your current home, a home equity loan may be a solid alternative to bridge loans.
Total debt climbs
Whether a homeowner takes a bridge loan or a hybrid stand-in, however, a significant amount of new debt will end up being added to the pile. The Cambridgeport borrower, for instance, would have to make three payments each month in order to cover the old home’s mortgage, and the first and second mortgages on the new house.
But even though they aren’t the best deal, bridge loans or other short-term mortgage financing products may be necessary when homebuyers land in tight spots, lenders say. There will always be people relocating for work without much advance notice, trying to keep others from beating them to the punch on a property, or needing help with the expensive upfront costs of buying a new home before their old one sells.
“It’s a way for the customer to get into that home without having to go through all the gyrations of trying to get cash for a down payment,” says John Bollman, a mortgage product manager with National City Corp. in Dayton, Ohio. “The Realtors tend to use it as a tool to help buyers buy their home.”
Bridge loans nevertheless remain relatively obscure in a lending landscape dominated by more widely publicized home equity loans and lines of credit. A fast-churning real estate market also eases the demand because it shortens the amount of time it takes for people to sell their homes, Hughes says.
Norwest, for instance, said only 140 of the 240,122 mortgage loans it extended last year were bridge loans, while Continental Savings Bank, based in Seattle, closes just four bridge loans a month on average out of 775 total mortgages.