Buy Before You Sell: What Is A Bridge Loan?

Moving to a new place is easier said than done. What do you do when you haven’t found your dream home yet? And where do you stay once you sell the first one? Do you even know when that ideal client will appear and buy it?

What Is A Bridge Loan?

Although not a preferred option, bridge loans may be the solution. These agreements allow you to fund your home purchase with the future sale of your property. Private companies use to approve borrowers fast regardless of the credit score. But is it the cost worth it? Let’s do the math:

For this example, you’re selling your home and buying another one (both priced at $100K). You need equity to qualify, which should be equal or greater than the combined 20% of both properties. That is 20% of 100K, 20K and 20K: 40K.

But how much can they lend you? The amount is the combined 80% of both minus the amount owed:

  • If you already paid 40K for your mortgage, 60K is left.
  • 80% of both values (200K) is 160K.
  • 160 minus what you still owe (60K) makes the amount they are willing to lend: 100K.

Advantages of Bridge Loans

#1 Freedom of selection

Although it’s not the cheapest option, it may give more freedom in the short term. Depending on the home equity accumulated, you could look for properties beyond your budget. If the homes you’ve found don’t convince you, it may be a good idea to broaden your selection.

You still may feel worried about how to pay off that bridge loan later. But the sooner you find and move to the new place, the more time you’ll have to sell the other one. Commit first, figure out later.

#2 Move once

Is that even a benefit?

It is if you don’t know where to stay while you’re selling a house and looking for a new one. You may probably send everything to a warehouse or second property, later to the new home. You spend twice the time and energy (maybe more when deciding where to send everything).

If you get a bridge loan, you only move your belongings from house A to house B. Imagine all the stress you save if you keep things that simple. As an indirect effect, you can focus better at selling your home while enjoying the new space. You neither need to look for a third home where to live.

#3 Get approved fast (even with bad credit)

Hard money loans don’t require excellent credit to qualify. Some bridge lenders will let you apply if your property has enough value to serve as collateral.

Often used in real estate transactions, only individuals and private companies offer hard money loans. Traditional lenders and banks won’t do it due to the risks. How trust someone without taking into account the credit score? It seems hard money lenders still make profits even if you default on your loan.

That doesn’t mean hard money is for everybody. Lenders try to compensate that risk by setting higher fees. It may not benefit you long term as much as a traditional loan.

Anyhow, it allows you to buy the house by leveraging your previous one. You may have poor credit or no money and still get the bridge loan. Just make sure to have a debt prevention plan.

The Problem With Bridge Loans

Because of the costs, most people should look at bridge loans as a last-resource solution. And even if you have enough money, you still don’t know when you will sell your house.

Here are three reasons banks stopped offering them:

High risk

You’re essentially trusting your money to a person, expecting them to sell the property. Since they are already buying one, it may give some sense of security. But what if it never sells? 

You don’t know what home they are selling, nor how good the client is managing money (credit score). But if you find the right borrower, bridge loans could make you a profit. That’s why lenders consider it investing instead.

If you can’t sell the house, you can’t pay back your lender, and debt starts to build up.

Interest rates are higher

These rates require you to be more cautious with the amount of money you borrow. Because interest accumulates faster, you might get to the point where debt grows faster than your savings.

Higher fees may mean more money for the lender. It also means a lower chance of getting paid since the borrower may fall behind.

If you have one, only take bridge loans if your emergency fund can cover it. Delay it for too long, and the interest will consume your house sale profits.

Total debt increases

You may prefer to manage a single mortgage loan rather than two or three. But bridge loans don’t necessarily minimize payments: on the contrary.

Consider that the market is unpredictable, and your house price may change every day. You may pay more than you expected, and the last day you have to pay back the loan is the day your house sells.

Let’s hope it doesn’t happen, but it’s good to be ready for everything: say your property doesn’t sell. After six months to a year, you may need to refinance your loan, which accelerates the accumulation of debt.

Before you get a bridge loan, calculate to see if you can afford the risks. The average loan costs at least 2% more than than a monthly mortgage payment.

How To Apply For A Bridge Loan

Bridge loans take little time to get approved. You could get the money as soon as this week.

Although lenders may ask for your exit strategy (how you plan to repay the loan? when is it due?), we’ll use the same example: you want to sell the house you own after buying a new one.

Gather your documents for the proof of identity, address, and income. Since the sale of your property is your exit strategy, most lenders will approve you quickly, especially if you have people already interested in this property.

Based on your deposit size, lenders may ask about your experience selling properties, how you plan to use the funds, or even a business plan (for property development, renovations, or commercial buildings).

We recommend you pay your lender as soon as the home sells. Due to the high rates, there’s no point in prolonging the funding.

The Bottom Line

Lenders are willing to help people who know how to manage money and earn passive income in the process. Although everyone prefers excellent credit scores, there’s no rule preventing you from getting the loan. Your lender will decide based on the gravity of the situation, your background, property, and plan.

If your credit score is preventing you from getting a loan you want, we have a guide here on how to increase it rather quickly.

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