Bridge loans are popular in certain types of real estate markets. Whether bridge loans are a good option for you depends on several factors. The reason buyers take out a bridge loan is to buy another home before selling an existing residence. That may sound like an ideal solution, but a bridge loan is not without risk.
For example, when a home buyer is buying another home before selling an existing home, two common ways to find the down payment for the move-up home is through financing either a bridge loan or a home equity loan (or home equity line of credit).
We advise sellers to wait before buying a home and sell the existing home first, but many feel an urge to locate their move up home first.
If you are absolutely certain your existing home will sell, it will alleviate fears about what happens if it does not. You might want to talk with a trusted advisor before pursuing a bridge loan. The main advantage to a bridge loan is to avoid a contingent offer and make your move-up offer all that more attractive to a seller.
Generally, a home equity loan is less expensive, but bridge loans contain more benefits for some borrowers. In addition, many lenders will not lend on a home equity loan if the home is on the market. Smart borrowers will compare the benefits between the two loans to determine which a better fit for their particular situation is, and plan ahead before making an offer to purchase another home.
What Are Bridge Loans?
Bridge loans are temporary loans that bridge the gap between the sales price of a new home and a home buyer’s new mortgage, in the event the buyer’s home has not yet sold.
The bridge loan is secured to the buyer’s existing home. The funds from the bridge loan are then used as a down payment for the move-up home.
How Do Bridge Loans Work?
Many lenders do not have set guidelines for FSCO minimums nor income ratios. Funding is guided by a more “make sense” underwriting approach.
The piece of the puzzle that requires guidelines is the long-term financing obtained on the new home.
Some lenders who make conforming loans exclude the bridge loan payment for qualifying purposes. This means the borrower is qualified to buy the move-up home by adding together the existing loan payment, if any, on the buyer’s existing home to the new mortgage payment of the move-up home. The reasons’ many lenders qualify the buyer on two payments are because:
- Most buyers have an existing first mortgage on a present home;
- The buyer will likely close the move-up home purchase before selling an existing residence; and
- For a short-term period, the buyer will own two homes.
If the new home mortgage is a conforming loan, lenders have more leeway to accept a higher debt-to-income ratio by running the mortgage loan through an automated underwriting program. If the new home mortgage is a jumbo loan, most lenders will restrict the home buyer to a 50% debt-to-income ratio.
Home Buying Benefits of Bridge Loans
- The buyer can immediately put their home on the market and buy without restrictions.
- Bridge loans may not require monthly payments for a few months.
- If the buyer has made a contingent offer to buy and the seller issues a Notice to Perform, the buyer can remove the contingency to sell and still move forward with the purchase.
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