Buying a new home and simultaneously selling your old one is never easy. You can either sell first and find temporary housing while you build or buy your move-up home, or you can buy first and foot the bill for two mortgage payments while you work to sell the old one.
Neither choice is ideal — and both mean serious stress. Fortunately, there’s a third option that might offer a more manageable solution: a bridge loan.
With a bridge loan, you can pay for the up-front costs of your new property, while selling your existing home behind the scenes. Once you sell the house, you can pay off your new loan (as well as anything remaining on your old mortgage) from the proceeds.
How a Bridge Loan Works
Bridge loans are a type of short-term financing — and they’re popular with homeowners who need to sell their current home before buying or building a new one. With bridge loans, your existing home acts as collateral, so the amount you can borrow depends on how much equity you have in the property. Usually, a lender won’t go higher than 80 percent of the home’s value.
Bridge loans can be used to pay for the down payment, construction expenses, closing costs and more on your new property. They can also pay off the remaining balance on your existing mortgage, so you don’t have multiple payments to deal with while you sort out your home sale.
Depending on how your bridge loan is set up, you might make monthly loan or interest-only payments, or you might have no payments whatsoever, instead making a single, lump-sum payment at the end of the term (typically six months to a year).
A Real-Life Example
Here’s how a bridge loan works in real life: Let’s say you’re looking to build a new home. Unless you have a lot of savings, you probably need the proceeds from your current home’s sale to afford your new property.
While you could sell the home now, that would leave you without a place to live while your new house is under construction. To avoid this hassle, you might consider taking out a bridge loan against your current property, using the funds to pay off your existing mortgage, as well as cover the down payment and closing costs on your new property.
Getting a Bridge Loan
There’s no set-in-stone standard for bridge loans, so the eligibility requirements vary greatly from lender to lender. Generally though, lenders tend to require fairly high credit scores for bridge loans, as they’re riskier than other loan options out there (they require high dollar amounts and they don’t have Federal Housing Administration backing to protect the lender if you fail to pay up).
You’ll also need a low debt-to-income ratio and significant equity in your home. Lenders usually won’t consider you for a bridge loan if you have less than 20 percent equity in the property.
Generally, you can expect the following fees and expenses when taking out a bridge loan:
- Origination fee
- Appraisal fee
- Administrative fees
- Various title fees
The exact amounts for these will depend on your lender and your loan balance, among other factors. If you think a bridge loan could be right for your situation, you’ll first need to find a lender who offers them. Not all mortgage lenders do, so be sure to shop around and get a few quotes. Rates and terms can vary significantly between lenders.
Pros and Cons of Bridge Loans
Ideally, the sale of your current home and the closing date of your new one would align perfectly, and you could seamlessly transfer the proceeds from one transaction to the next. Unfortunately, this rarely happens, but with a bridge loan, that’s OK.
Bridge loans give you a little leeway in timing, and they help take some of the financial stress out of buying and selling simultaneously. They can also give you a leg up on other buyers and ensure you have a place to live while you close on your new home (or build it from scratch).
The biggest downside to bridge loans is that they’re expensive. Because bridge loans are short-term loans, lenders have a lot less time to make a profit. To make up for it, they’ll charge more in interest than they would on other loan products (usually at least a few percentage points higher than a 30-year mortgage). Luckily, you’ll only pay this high interest rate for a few months (maybe a year max), so it still may be worth it to buy or build that dream home.
- You can take your time selling your existing house.
- A bridge loan prevents you from having two mortgage payments at the same time.
- It can give you an edge with sellers (you won’t need a sale contingency in the offers you make).
- You can make your down payment and closing costs without a lot of savings or hassle.
- You can stay in your existing home while you shop for a home or build a new one.
- Getting a bridge loan is often faster than it is for other financing products.
- Bridge loans come with higher interest rates than other financing options.
- You’ll still need to secure long-term financing for your new home.
- Your house is used as collateral.
- You’ll need a high credit score and significant equity in your home.
- They have higher-than-average origination fees.
- You could find yourself with multiple mortgage payments if you can’t sell your home fast enough (or a buyer’s financing falls through).
Alternatives to Bridge Loans
Bridge loans aren’t the only option if you’re looking to buy or build while selling your old home. You can also look into home equity loans, home equity lines of credit or construction loans.
Another option? You can sell your home first but include a lease-back in your sales contract. This would allow you to stay in your home (technically renting it from the new owner), while you close on your new property.
However you choose to go about it, the bottom line is simple: Buying and selling at the same time might have its challenges, but it’s not impossible by any means. Want more information about buying or building a new home? Check out our buying and financing guides now.