Ready to make the move to a new home? Bridge financing can be an elegant solution to the logistical and fiscal challenges of transitioning from your old to your new home.
So many options
Buying your first place can be exciting and scary, but the logistics, at least, are simple. Shop, write an offer, give notice to your landlord, close and move. Alas, the logistics of a move when you already own a home are not as simple. And some of the potential paths forward can be less-than-appealing.
Listing your current home for sale and taking a leap of faith that the perfect new home will hit the market is one option… but what if the right home doesn’t come along in time? You could wind up scrambling for interim housing.
If you don’t want the pressure of trying to dovetail the timing of your sale and purchase, you could plan on moving twice. Put your stuff in storage and rent a place to stay while between houses. But moving isn’t fun — and moving twice (even if it’s planned) is double the hassle and expense.
Another option is to hold off on listing your home until you find the place you want to buy. When the perfect new home comes along, include a contingency for selling your current home in your offer. Sounds easy enough. But, of course, your seller must be willing to accept a contingency. Many are not — especially if you are competing against other offers.
As the infomercials say… There’s gotta be a better way.
Buy first, then sell
An obvious answer is to decouple the timing of your purchase and sale by buying your new home prior to selling your old home. The logistics of your move get a heck of a lot easier. Shop for the right place, write a strong (non-contingent) offer, close, get your keys and make the move at your leisure. Then prepare, stage, list and sell your old home. Easy peasy.
Or maybe not… all the equity in your old home is still tied up and unavailable to put down on your new home until you sell. If you can’t find an alternate source of funding for your down payment, you could be back to square one.
This is where bridge financing comes in.
What is a bridge loan?
Using a bridge loan, you may be able to leverage the equity in your current home to buy your new home. If you have enough equity in your old home, you may even have the option to buy your new home with zero cash down payment.
How does it work?
Bridge financing offers the unusual opportunity to finance two homes using one loan. This is called “cross-collateralization”. The lender uses both your old and new home as the collateral for your mortgage, which means you get credit for the equity in the old property toward the purchase of the new property.
Let’s say your current home value is $500,000 and you owe $100,000 on your mortgage and $50,000 on a home equity line of credit. You want to buy a $700,000 home. You’ve been living in your old home and plan to move into the new home The math goes like this:
$500,000 + $700,000 = $1,200,000 total value of homes
$1,200,000 x 0.75 = $900,000 gross equity
$900,000 – $150,000 debt = $750,000 net equity available
With $750,000 available equity, you could finance a $700,000 with no cash down payment required. The $50,000 of extra available equity can be used to finance your closing costs.
Plan for the interim
When using a bridge loan, don’t forget to plan for the inevitable interim window of time when you’ll own two homes. You’ll need to carry the cost of both homes from the day you close on the purchase of your new home until the day you close on the sale of your old home.
Some bridge loans pay off your existing mortgage on your old home at closing, others leave your old loan(s) in place. If the bridge loan you’ve chosen doesn’t pay off your existing mortgage, don’t forget to budget for continued payments on it until you close on the sale of your old home.
Selling your old home
Most bridge loans have no deadline by which you are required to sell your old home (although you’ll probably want to sell as soon as you can). When you close on the sale of your old home three things will happen:
• Release of lien – The lender will release the lien on your old home. This enables your buyer to secure financing and close on their loan.
• Principal reduction – The bridge loan accessed some — but not all — of your home equity toward the purchase of your new home. Selling your home frees up the rest of your equity. The title company will calculate how much cash you are due at closing (less selling costs). You may be required to pay a portion of the proceeds down on your new loan. The amount you’ll be required to pay is calculated by the underwriter when your loan is approved. And of course, you’re welcome to pay more (or even all) of your net proceeds down on the loan. If you clear enough from the sale, you may be able to entirely pay off your bridge loan.
• Recast – If you can’t entirely pay off your loan, you can request a “recast” of your payment. A recast (described in more detail here) resets your monthly payment to reflect the new, lower balance. Recasting means you won’t be stuck with a huge payment, based on what you originally borrowed. Expect to pay a fee in connection with recasting your loan ($250-$350 is typical).
Some important details
Oregon, Washington & California
Bridge loan programs are niche loan options offered on a regional basis. The options discussed here are offered in Oregon, Washington and California — and lending areas for some options may be limited within these states.
No crossing state lines
Because your new loan is going to be recorded as a lien against two properties, they most both be in the same state. The document lenders use to file a lien against a property (called a “trust deed”) is state-specific, making it impossible to cross-collateralize homes in different states.
Qualifying for a bridge loan offers leeway to traditional debt-to-income ratios. If you can qualify for the projected payment (after you sell and recast) and demonstrate the ability to carry payments in the interim, you have a good chance of securing approval for a bridge loan with what would otherwise be an unacceptable amount of debt relative to your income.
Bridge loans are a little more complex than a traditional purchase and therefore take a little extra time to process. If the existing property being collateralized is your primary residence, there is also a mandatory 3-day waiting or “recission” period between the day you sign documents at the title company and the day you close. Plan on about 45 days from the day you get your offer accepted to closing.
Closing costs are higher
Closing costs on bridge loans are generally higher than the closing costs on a more traditional loan. In addition to typical closing costs, you can expect to pay for a second appraisal and 1.5% to 2.0% of the loan amount in origination fees.
Despite the higher closing costs, there are some potential financial gains to keep in mind. You will not have to pay for moving twice, rent on interim housing and/or storage costs. An offer with no contingency for selling your home may give you leverage negotiate more favorable terms on your home purchase.
You may fetch a higher price for the home you are selling if you are not in a rush to sell it. Ask your Realtor how clearing out you (and maybe kids and pets), tidying it up, making improvements and staging will could change your selling price.
Whether the higher costs of a bridge loan are worth paying is something you’ll need to decide… but maybe your bridge loan can pay for itself.
DIY “Bridge” options
Before signing up for a bridge loan, let’s explore all your options. You may be able to buy your new home something bridge-like that offer many of the benefits of a bridge loan without the higher cost.
Do you have savings, access to gifts or a retirement account you can borrow from? Maybe you don’t need to access your home equity to buy. Or,you could free up some equity for a down payment using a home equity line of credit, rather than a bridge loan. Let’s talk and see if we can get creative.
If you’re contemplating a move to a new home, let’s strategize! Share your goals and we will explore loan options — seeking your optimal financing solution. It’s out there and together we can find it.
I look forward to hearing from you!
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