Buying a New Home - Bridge Loan vs. Home Equity Loan

Home sale contingencies in your home purchase offer can be a major buzzkill in any home buying market. To combat the toxicity of an offer contingent on the sale of the buyer’s home, or perhaps to help with the short term costs of financing a new home, many home-buyers turn to bridge loans. Bridge loans, as the name implies, are intended to help home-buyers make the transition from one mortgage to a new first mortgage while waiting for their existing home to sell. But for many home-buyers, the costs of a bridge loan comes dangerously close to outweighing the benefits. For some borrowers, a home equity loan may be a safer alternative.

Bridge Loans Pros and Cons

Bridge loans are most advantageous when kept on the books for a relatively short period of time. Bridge loan terms are structures vary widely - for example, a bridge loan may completely pay off your first mortgage while others roll your first mortgage into the mortgage for the next home you purchase - but in general, they are designed to be short term financing tools. Most bridge loans have a term of six months, are secured by your first home and have an interest-deferred period. If your home moves fast, then this can be a good deal. But if your house languishes on the market, you can easily find yourself in hot water. After the interest-deferred period, you’ll have to start making interest payments for the entire life of the loan. The interest rate can be anywhere from the prime rate to the prime rate plus 2 percentage points. At the end of the initial six month term, your bridge loan either becomes due in full or the bank can renegotiate the terms. Furthermore, the closing costs for a bridge loan are high in some cases, they may even rival the closing costs for your home purchase mortgage.

Bottom-line: A bridge loan comes with lots of strings attached, and a lot of the money you’ll be paying goes right to the bank. The longer you have a bridge loan, the more costly it becomes. For that reason, getting a bridge loan is essentially a gamble on whether or not your home will sell.

Home Equity Loans Pros and Cons

A home equity loan is a more conventional type of home financing. A home equity loan that you take out to help you cope financially while you transition from one home to the next is the same type of home equity loan you’d take out to make home improvements, consolidate debt or pay for college. As such, home equity loans tend to be less costly upfront (with closing costs under $1,000), easier to qualify and less costly over the long term. Home equity loans are designed to be paid off over a term of 3 years, 5 years, or longer. Because of this, the financial impacts of your home sitting on the market beyond 6 months are much smaller.

The main catch of a home equity loan is that you can’t take out a home equity loan if your house is listed on the MLS. That means you’ll have to take out your home equity loan before you put your house up for sale - it’s the law. Also, in the case that your home doesn’t sell, you’ll find yourself paying three loan payments each month: your first mortgage on the home you’re trying to sell, the mortgage on the home you just purchased and the home equity loan on your listed home that you used to finance your new home.

Bottom-line: A home equity loan is a more conservative approach that takes a more proactive approach (you have to finance before listing your home) but is less costly if your home doesn’t sell. You may also want to consider a home equity line of credit to help you finance your new home.

Conclusion

Bridge loans are risky - that’s why they come with high costs, most of which are borne by the borrower. With a bridge loan, you’re going to pay more interest, higher closing costs and more administration fees. But if you are confident that you can sell your home before the interest-deferred period is up (usually just a few weeks to a few months), then a bridge loan may work for you. Then again, if you think your home will sell, it might make more sense to simply stay put until it’s under contract. For those who need that extra cash to cover closing costs or pay down their interest rate on their new home, a home equity loan is a low cost financing option that protects you against devastating interest payments even if the sale of your house doesn’t go as quickly or smoothly as you’d like.