Say you bought a house several years ago. You took out a physician mortgage loan, and settled down into your new home. Not long after though, life calls — it's already time to move again.
As a doctor, this could mean you:
- Finished residency and plan to launch your career in another city.
- Have been practicing for awhile and discovered a great new opportunity.
- Received a raise and would like to move into a larger, nicer home.
- Are ready to build the custom home of your dreams.
Except there's one issue — you haven’t sold your current property yet. Regardless of your motive for moving, you now have a big question to answer.
Can you afford to finance a new home before selling your current property?
For many doctors in this situation, a bridge mortgage loan is a viable option. However, it's crucial to first weigh the pros and cons of this type of financing to see if it's right for you.
What is a bridge mortgage loan?
A bridge mortgage loan allows you to borrow against your current home you're trying to sell in order to finance a new home. Bridge loans are short-term mortgages, which typically last from six months to a year.
There are two ways to structure this type of loan.
- Use the new financing to pay off the mortgage and any liens on the current property. Once it sells, the proceeds will pay off the bridge loan. Then you just have the mortgage on your new residence.
- Treat the bridge loan as a second mortgage. Think of it as buying a vacation home or investment property. The bridge loan serves as a downpayment on the new house. Under this structure, you will make two mortgage payments until the first home sells.
Seems pretty cut-and-dry, right?
The fine print on bridge mortgage loans
As you might expect, bridge mortgage loans present added risk to the lender. So it's no surprise they carry high interest rates and fees.
On average, the interest rate on a bridge loan is a full two percentage points higher than a standard mortgage. Likewise, fees may cost more than one percent of the outstanding loan balance.
Qualifying for a bridge mortgage loan is also more difficult than others. Lenders rarely grant a bridge loan unless you agree to finance your new home's mortgage with the same institution.
Most lenders will only allow you to borrow up to 80 percent of your current home's equity. This means you need a minimum amount of equity in your current home. And if your new mortgage is a jumbo loan, most lenders will restrict you to a 50 percent debt-to-income ratio. (A jumbo loan amount exceeds $424,100 in most of the continental U.S.)
As previously mentioned, bridge loans are short-term mortgages. That means the loan balance is due at the end of the term, typically six months to a year. Lenders will not want to hold on to bridge loans for very long.
If you haven’t sold your first home and can’t pay off the bridge loan by end of term, the lender may foreclose. However, many will choose to extend the loan. But not out of good faith --- this allows them to spike interest rates and fees.
The process for obtaining a bridge loan is also quite different from that of a traditional mortgage. Lenders do not use the same underwriting guidelines to determine your creditworthiness. Instead of checking your credit score and income history, lenders will confirm your budget can handle the higher combined payment. If so, be sure to compare lenders and the rates and terms they offer before signing off.
The best alternatives to bridge mortgage loans
As you can see, taking out a bridge mortgage loan can be risky. Especially if your home may be on the market for longer than the term of the bridge loan. It may depend on the current real estate market.
Fortunately, there are several alternatives to bridge loans.
Borrowing against your existing home. If you have enough equity in the home you are trying to sell, a home equity loan is one option. It will allow you to make the downpayment on the property you’re trying to buy. Since you’re trying to sell the home, losing the home equity won’t matter too much. After all, it makes sense to use the proceeds from the sale of the first home as a downpayment for the second home. This arrangement just accelerates the process.
Rent instead of buying right away. You may want to consider renting in your new city while you search for a new home. This will afford you more time to:
- Sell your existing property.
- Weigh your options before making your final decision.
Keep your existing home and rent it out. For most homeowners, this is not a convenient option. But if the real estate market is down and you’re having trouble selling, you could rent the property out. The proceeds will then take care of the mortgage payment and any maintenance needs. Of course, there many downsides to this alternative, including:
- The potential of having the home damage by tenants.
- Having to collect rent from delinquent tenants.
Still, it can buy you the time you need to build more equity in the property.
Extended-stay executive housing. Another temporary option is extended-stay housing, which you can rent on a weekly or monthly basis. Already furnished, these facilities cater to professionals transitioning from one place to another. Better yet, this will prevent you from getting locked into a rental lease.
Life happens fast. If you need to sell your home sooner than you planned, a bridge mortgage loan may be the right solution for you. Given the risk attached to this type of financing, it's important to understand:
- The pros and cons of bridge mortgage loans.
- Viable alternatives to bridge mortgage loans.
- How the current real estate market impacts your decision.
A clear understanding of these implications, you should have a much better idea if this major financial decision is a smart one to embrace.