Unlike some other lending products, whose names often confuse non-financial people, bridge loans are graphically accurate terms. When you buy another house before selling your current one, you often face income and cash challenges to complete your new home purchase. Enter bridge loans, which allow you to buy your new home before you sell and close on your current residence. This financing builds a "bridge" between closing on your new home and the sale of your current house.
Home Equity Loans
You might think that a home equity loan is cheaper and a better alternative to bridge financing. You'd be correct, but most lenders will not give you a home equity loan when your house is actively for sale on the market. You won't have the opportunity to take advantage of typically lower home equity interest rates and closing costs. Properly structured bridge loans can help you disregard the typical home equity loan benefits.
Bridge Loan Advantages
Bridge loans are temporary, bridging the gap between closing the purchase of your new home and selling your current house. Bridge lenders take your current home as collateral, with these loans acting as a second mortgage or an equity loan, to give you the down payment for your new home. Bridge loans allow you to complete the purchase of a new home before you have the proceeds from the sale of your current home without causing you to default on your purchase contract or destroy your bank account.
How They Work
You'll own two homes for, hopefully, a short period, but you will be able to close on your new home. Your bridge loan lender will advance you funds representing your equity and future cash proceeds from your current home sale. As soon as your current home sells and closes, your proceeds will pay off the bridge loan. You'll pay interest from the day you got the bridge loan until you sell your home and pay off the loan.
Monthly payments are seldom required on bridge loans, at least for a few months. There are normally fees, giving your lender an opportunity to earn income above interest. You may need to pay one-half to one point -- one point equals 1 percent of the loan amount -- for this financing. There may be other closing costs, such as escrow or recording fees, to close this temporary loan. If the sale of your current house takes awhile, you may need to make payments on two mortgages for a few months or pay more interest than you might like.
For all the benefits of bridge loans, they come with a few downsides. You'll pay more in interest and fees than you would with most equity loans. You'll also need to qualify to make two mortgage payments, if necessary, which is a challenge to many borrowers. You will pay fees that may appear excessive for a short-term loan. Shop around, since bridge loan terms vary widely.