Buying a home can be as complicated as it is exciting. If you have to sell a home in order to buy a new one it adds another layer of complexity, but also a possible opportunity for getting what’s known as a “bridge loan,” a unique financing opportunity.
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According to Warner Quiroga, a real estate investor and president and CEO of Prestige Homebuyers, “A bridge loan is a temporary loan used to finance the gap between selling an old property and purchasing a new home. This type of loan is sometimes called a ‘gap financing’ loan.”
These kinds of loans exist in order to give you time to sell your current home to have enough money for the down payment on your new home.
When To Consider a Bridge Loan?
Many people start looking for bridge loans for real estate transactions when they want to go ahead with a purchase or a sale but need to get the time it takes for their loan approval, Quiroga explained. “This is especially true when you are closing on a property in probate, and your lawyer or the judge requires you to put up money as a condition of closing.”
If you’re just in need of fast cash, a bridge loan may not be your best bet, however. “When you need funds fast, it’s best to talk to your bank about a personal cash advance or try contacting your credit union for a home equity loan,” Quiroga said. “A bridge loan is ideal for investors who need additional capital to cover closing costs or profit on a real estate transaction before the end of the escrow period.”
How To Qualify for a Bridge Loan
Borrowers may be able to secure a bridge financing loan from their lender or another private lender. Bridge loans have shorter terms than typical mortgages, often lasting up to one year, so they are best suited for borrowers in transition. Quiroga said. “They are relatively easy to acquire and fast to close, but they require strong credit and equity in the property being purchased.”
To get one, you’ll need:
Proof of funding for permanent financing
Proof that you have enough income to cover the mortgage and living expenses for at least six months
Proof that you have enough equity in your current home to cover the amount needed for permanent financing
Proof that you have a down payment saved and ready to go when closing the new home
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A typical bridge loan is a short-term loan (usually 12 months or less) that covers the gap between when you have enough cash to buy your dream property and when you’ll have enough income from the investment property to pay off the loan.
Use a Bridge Loan to Access Equity
Since bridge loans enable homeowners to access equity from their existing home before it is sold, according to Michael Branson, CEO of All Reverse Mortgage, “This can provide them with needed funds for a home renovation or other large expenses.”
He added, “Some people use bridge loans to finance a flip property when they need immediate access to cash and don’t want to wait for traditional financing. This type of loan is also helpful when refinancing an existing mortgage and needing extra funds to cover costs.”
Bridge Loans Can Prevent Contingencies
In addition to simply trying to buy a new home before you’ve sold your current one, there are other reasons to get a bridge loan. According to Shubham Badhi, a finance professional with Kotak Securities, you may want a bridge loan to prevent contingency clauses.
“Contingency clauses in real estate contracts permit buyers to back out of buying a property when certain conditions are not satisfied,” Badhi explained. “Through the bridge loan to buy an additional property prior to selling their current property, buyers can get rid of these contingents and present a more convincing offer.”
Be Aware of Interest Rates
Bridge loans are intended to be temporary financing solutions, with periods of only a few months to a year or two, according to Jonathan Merry, founder and CEO at Bankless Times. Due to the high interest rates that can accrue on overdue bridge loans, it is crucial that you have a strategy in place to pay back the loan on time, Merry warned. Or, try to refinance your loan as quickly as you can.
Disadvantages of a Bridge Loan
While bridge loans are an excellent way to sell and buy a house at the same time, Eli Pasternak, a licensed real estate agent and the founder of Liberty House Buying Group, warns that a “bridge loan’s drawbacks often include a high interest rate, expensive transaction fees, and the unpredictability of the sale of the assets that the money is lent.”
Pasternak added, “Bridge loans are designed to be short-term solutions for releasing money that is held in reserve while waiting for the sale of the real estate assets.”
There’s also the risk that the borrower of the bridge loan will use the bridge loan money to purchase a new property but fail to sell the one they are trying to sell. “Consequently, the buyer would now have three debts rather than one,” Pasternak said.
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This article originally appeared on GOBankingRates.com: Transitioning Homes? This Loan Can Make It Easier