Home Equity: Understanding Bridge Loans

You've found the perfect house for you and your family, but the house you're living in hasn't sold yet. Where are you going to get the money to make sure that the new house doesn't get away? A bridge loan, although risky, may get you through these troubled waters.

Remember when you were young and on your family vacation, and your parents would drive over a very high, narrow bridge? You were petrified and thrilled at the same time. Bridge loans, although having nothing to do with water, can elicit the same feelings. These instruments give people the opportunity to buy the house of their dreams before they've sold their old one-but the risks can be dizzying.

Building the bridge

There are two types of bridge loans. The first pays off the mortgage on your current home and makes a down payment on the new one. This means that you pay the mortgage only on the new property, agreeing to repay the bridge loan when the old home sells.

The second type of bridge loan is more risky, allowing you to borrow against the equity of the current home to use for your down payment. The scary part is that while you're paying off a bridge loan, you're still responsible for the mortgage payments on both homes.

Short Term Benefits

The bridge loan can provide that short-term influx of cash that you need to secure your new home. Although the loan typically requires interest-only payments, the rates and fees may be higher and carry significant pre-payment penalties. Before going down this path, talk to a real estate agent to find out how long houses such as yours are taking to sell. If the market is really slow, determine if you have the finances to pay two mortgages for that length of time. The risk-and it's substantial, especially in this buyer's market-is that your current home will be slow to sell, leaving you with essentially two mortgage payments for some time, straining even the best breadwinners.

The alternative: A HELOC

A home equity line of credit (HELOC) would give you enough money for the down payment on the new house and you're your closing costs, but is much less risky than the bridge loan. In order for this to work, you must apply for the HELOC before you put your house on the market. Many lenders won't let you borrow against the equity in your current home if it's for sale.

Going over a bridge is always breathtaking. It's the same with a bridge loan. It could be the very thing you need to secure the house of your dreams, but weigh the risks carefully. Other alternatives, like dipping into your home equity, may save you many frightening moments while getting you to your destination safely and happily.