What are bridge loans?
Bridge loans are intended to be short term arrangements whereby someone buying a home can close their purchase before they've sold their existing property. In other words, you effectively get a mortgage on your new house before you've sold your current one and repaid the home loan on it. Doug Cameron, a former Realtor, explains that there are two principal types of bridge funding for residential purposes:
- The bridge lender pays off your existing mortgage and can provide the funds for your down payment. You generally don't have to make any payments on the bridge (just on the new mortgage) until you sell your current home and the principal and interest are paid out of the proceeds. However, this grace period is likely to last only six months, after which you could find yourself paying two mortgages
- You borrow against the equity in your existing house, though the value of the bridge is usually capped at 80 percent of that equity. Again, you may be granted a period when you don't have to make payments on the bridge loan. However, if the bridge financing doesn't cover the full purchase price of the new home, you're going to have to pay your existing mortgage and the one on the new property.
Home equity line of credit-v-bridge loan
Many financial advisers say that bridge loans are a bad idea, and that a home equity line of credit that achieves much the same thing is likely to be less expensive. Having said that, not everyone has enough equity in their current property, and for them a bridge loan may be the only way forward.
Why aren't bridge loans more popular?
Leaving aside the expense, few people today are willing to buy a home using a bridge loan or a home equity line of credit. The problem is exposure to risk.
It's always been true that purchasing a property before selling an existing one is something only those with nerves of steel would entertain. But that's twice as true now. Current low mortgage rates don't compensate for a property market in which it can take many months--or years--to sell a home. And, of course, falling house prices in many parts of the country mean that the most careful, conservative calculations of the affordability of a transaction can quickly be overtaken by events.
New forms of bridge loan
The New York Times ran a feature recently about a new (well, it's been around since 2003, but few have heard of it) form of bridge loan especially for seniors. This provides a line of credit of up to $50,000 for older people who urgently need to move into an assisted-living home or independent community before they're able to sell their houses.
The best thing about the bridge loan described in the Times is that it's repayable (both the principal and interest) in five years so there's no need to dispose of the home or other assets as if they were in a fire sale. The downside is that interest is charged at anything between 8.25 and 12.5 percent depending on the debt-to-income ratio and the applicant's credit record.
Another topic covered by the same Times feature was intrafamily reverse mortgages. Ordinary reverse mortgages provide a borrower aged 62 years or older with a lump sum, line of credit and/or monthly income secured on his or her home. No repayments are made until the owner moves or dies. The idea explored in the feature is that family members rather financial institutions take the role of lenders.
These are all intriguing ways of raising money in unconventional ways. However, each has its drawbacks, and it's important to understand the small print and take expert advice before signing anything.