by Nancy Osborne, COO of ERATE®
You've finally found the home of your dreams and you're ready to make an offer. Only one problem, you have to sell your existing home to free up cash to purchase the new one. Just a few years ago you couldn't even consider making an offer on a home with a sale contingency (that is the need to sell your home first in order to proceed with the new purchase transaction). But what a difference a few years makes, the housing market has gone from jalapeño hot to iceberg cold in many locations around the country and now a seller is willing to consider almost any type of offer or contract contingency. So what do you do when you have trouble selling your own home in order to move up? Well you basically have two options, the traditional bridge loan or a home equity line of credit, (or HELOC) secured against your current residence.
The HELOC could be the faster more economical option of the two, particularly if you have a lot of equity built up in your home. The underwriting process can be handled in advance and your costs should be only a few hundred dollars (or even at no cost) in order to proceed with the loan. The interest rate paid on the line is typically based on the prime rate index +/- a fixed margin that is based on your credit rating. The key is that you must set up this financing prior to listing the property for sale or you will run into problems, so you should likely line up this financing before beginning your property search. Technically the lender will permit you to borrow against any asset which you own, including your 401(k), however the HELOC may be the easiest or pose the path of least resistance, assuming you have sufficient equity. The main drawback is that you must be able to carry all three payments, assuming you have a first mortgage outstanding on your current home. The three loans would include your mortgage on the new residence along with the first mortgage and the HELOC second mortgage on your current residence.
A bridge loan may be a useful tool in that you can borrow against the equity in your current home while you have simultaneously listed it and are attempting to sell it. However it can be more costly overall and typically carries a rate of interest that is several percentage points above that of the 30 year fixed rate with additional fees charged on the loan ranging from 2-4 points. Bridge loans are repaid at the time that the property is actually sold and may remain open against a property for a period of up to three years. A key advantage of the bridge loan is that you may not be required to make monthly payments on the loan as you would on other types of loans, including a HELOC, until the home is sold. The balance on the loan, along with all the accumulated interest due to the lender, are paid at the time the home is sold.
In the final analysis it appears that the HELOC is the least costly form of short term financing, assuming that you are able to carry all three payments and while the bridge loan is more costly, the re-payment is more flexible in that you won't need to worry about it until you are able to sell the home, within a reasonable time frame. In the end your personal finances may dictate which direction would be best for you. If monthly income or cash flow is not an issue, you may be wise to opt for the HELOC and if money is tight and you cannot swing up to three mortgage payments at once, you may want to go with a bridge loan. Keeping your options open to go in either direction is probably wise, so with proper planning you may want to have a HELOC ready for your use before you start your search.
Always consult with your tax or financial advisor regarding your own individual circumstances before proceeding with any plan which may have a dramatic impact on your personal finances.
Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.
"I am addicted to Bloomberg TV" says Nancy.