While it is easier to sell an old home before purchasing a new one, so the sale of the old house provides the money for the new one, this does not always work out. Sometimes homeowners find the new house they want before their old home is sold.
A bridge loan, also called a swing loan or gap financing, is a short-term, temporary loan used to secure the purchase of a home until longer-term financing is secured. With a bridge loan, the homeowner has the necessary funds to buy the new home, with the intention of repaying the loan with the proceeds from the sale of the old home.
Swing loans are just one option homeowners have when selling a home and buying a new home. The second option is a home equity loan, or line of credit. While home equity loans are usually less expensive, bridge loans may offer more benefit to some homeowners. Many lenders will also not allow a home equity loan for a property that is on the market.
Benefits of a Bridge Loan
Gap financing comes with several benefits:
- The buyer can immediately put their home on the market without restrictions, unlike a home equity loan,
- Bridge loans do not typically require a monthly payment for several months,
- If a buyer makes a contingent offer to buy, and the seller issues a Notice to Perform, the buyer may remove the contingency to sell and proceed with the home purchase.
Downsides of Gap Financing
- Bridge loans typically cost more than a home equity loan
- Buyers will be qualified by a lender to own both homes. Many fail to meet this requirement
- Making two mortgage payments, along with the accruing interest on a swing loan, can cause financial difficulty.
How Bridge Loans Work
Most lenders do not have set guidelines for a debt-to-income ratio or FICO score for swing loan borrowers. Instead, the funding is guided by common sense underwriting. Some lenders who make conforming loans exclude the gap financing payment for qualification purposes. This means the borrower is qualified to purchase a "move-up" home, by adding the existing loan payment on the existing mortgage to the new payment of the move-up home.
Lenders typically qualify buyers on both payments, because most buyers have an existing first mortgage. The buyer will most likely close the new home purchase before selling the existing home. For a short amount of time, the buyer will own both properties.
In most cases, a swing loan comes with a due-and-payable date determined by the lender. This is usually six months. If the first home has not sold after that time, it is usually possible to request an extension. Most lenders also add a due-and-payable-upon-sale clause, which means the loan must be paid when the first home is legally sold. There may be additional fees if the bridge loan exceeds six months.
Bridge Loan Costs
Swing loans typically run around 2% more than the interest rate on a 30-year, fixed-rate mortgage. Lenders may also charge higher fees for the loan, often more than 1% of the outstanding loan balance. While there may be no payments required on the loan for a certain amount of time, interest will accrue and be due when the loan is paid.
Fees for obtaining a bridge loan include an administrative fee, appraisal fee, escrow fee, title policy fee, notary fee, recording fee and a loan origination fee based on the amount of the loan.