In this article:
As your life evolves — more children, a new job, an early retirement — your housing needs evolve too. Suddenly, your idea of what your dream home looks like changes and it’s time to sell your home and buy a new one. Navigating this process is tricky, especially if you find your perfect next home before your new home has a chance to sell. This is why you may want to compare your short-term financing options.
When it comes to the bridge loan vs home equity loan debate, which route you choose depends on what type of interest rates you have available to you and what you need the funds for. You can utilize both types of loans to help cover a second mortgage, if you need to pay for a mortgage on both your new home and your existing home while you find a buyer.
To better understand, what is the difference between a home equity loan and bridge loan, read on for a breakdown of what both borrowing options look like.
What is a bridge loan and how does it work?
Terms: 3 – 6 months
Conditions: Requires collateral
Typical interest rate: 8.5% - 10.5%
A bridge equity loan lends a helping hand when someone needs access to funds to “tide them over” when they’re in a transitional period. These loans are commonly used to provide a financial cushion when a consumer is in the process of both buying and selling a home at the same time. Bridge loans amounts are typically small and only amount to about 3% of the purchase price of the new home you’re buying.
Bridge loans are a risky option for lenders, as there is a chance you won’t sell your new home and may struggle to pay this loan off. For that reason, bridge loans tend to have slightly higher interest rates than you would find with traditional 30-year fixed rate loans — ranging between 8.5% to 10.5%. To help offset their risk, alongside higher interest rates, these loans may also come with additional fees and require collateral in the form of your home to secure the loan. Tread lightly here — if you don’t make your loan payments and your home is acting as collateral, you risk the lender foreclosing on your home.
Lenders will look at your current mortgage responsibilities and any other debts you may have, as well as your day to day financial responsibilities, to try to gauge how likely you’ll be to repay your loan. You usually have the option to stick to a set monthly repayment schedule, or you can pay all of it back as soon as your home sells if you used the bridge loan to cover the cost of balancing two mortgages at the same time. You usually have to repay your bridge loan (including interest) within six months to three years, with the deadline typically being when your old home sells.
That said, it’s hard to nail down how long it will take to sell your home. If your home does not sell by the time your loan needs to be fully paid off, you can apply for an extension.
What is a home equity loan and how does it work?
Terms: 5 – 20 years
Conditions: Requires collateral and applying before your home goes on the market
Typical interest rate: 5% – 6%
A home equity loan also uses your home as a form of collateral, but unlike a bridge loan, you have to take out a home equity loan before your home is put on the market for sale. It’s necessary to plan ahead for a home equity loan, but the benefits may very well be worth it. Often, home equity loans have lower interest rates and fewer fees than bridge loans do. It is a challenge to qualify for a home equity loan if your credit history is poor, but when you use your home as collateral, lenders feel more comfortable issuing a loan as it is secured.
While bridge loans are typically due once your original home sells, a home equity loan can still be used even after the sale of your home. This is helpful if you have a lot of expenses to tackle post-sale, like needing to hire movers or buy furniture.
Home equity loans are a longer-term loan and the repayment period usually starts at five years and goes as long as 20 years. Interest rates for home equity loans tend to be more favorable than with bridge loans (around 5% – 6%), but if you take many years longer to pay it off, the interest will likely still add up to be more than with a short-term bridge loan.
A home equity loan really comes to the rescue when you need to balance the purchase of a new home before you sell your original home — but this isn’t a risk free borrowing option. If you can’t sell your original home, you may find you have to pay your original mortgage, new mortgage, and home equity loan, all at the same time.
When are these loans useful?
Even under the best of circumstances, moving is stressful. This is especially true when you need to meet all of the financial needs of your current home as you navigate a move to a new home that comes with its own expenses. To even get to that stage comes with financial strain.
Both bridge loans and home equity loans help provide the funds that make the purchase of a home while you try to sell an existing home more possible. In an ideal world, your existing home will sell before you close on your new home. But let’s face it, even the savviest real estate agent can’t guarantee that will happen.
As useful as both bridge loans and home equity loans can be, they do come with a decent amount of risk. If possible, taking out a bridge loan to cover moving expenses or the remaining few months on your mortgage before escrow closes is a safer way to go, as you know that your home has already sold.
What other financing options do home buyers have?
No matter where you are in the home selling or buying process, you have a variety of options to help make the whole experience less financially stressful.
Because both bridge loans and home equity loans use your house as collateral, they’re easier to obtain at a good interest rate even if you don’t have the best credit score. If your credit is in good shape and you’re able to secure a personal loan at a decent interest rate, consider that option. A personal loan may be a safer way to borrow money, as your house won’t be on the line if you end up struggling to pay back your loan because your house didn’t sell as quickly as you hoped.
Credit card with 0% APR
A credit card with a 0% APR introductory offer acts as a “free” form of financing if — and only if — you’re able to pay back what you borrowed before that introductory period ends and your interest rate shoots up. While this is a risky bet to take if you haven’t sold your home yet, if you just need help to cover moving costs or vital home purchases, a credit card with a low or 0% APR is a good fit for short-term borrowing.
Sell with a contingency in place
There are a few different home sale contingencies sellers can take advantage of to make the home selling process as convenient for them as possible.
If you choose to sell your home with a “home of choice” contingency, you can require the sale of your existing home to be contingent upon you finding a new home to purchase. This allows you to sell your home while you’re still looking for your next home. Such a contingency makes the whole process more convenient for the seller and is a good option in a seller’s market when competition for homes is fierce.
You may also sell your home to a buyer that agrees to a “rent back” contingency. This type of contingency allows you to move forward with a sale of a home, with a provision in place that enables you to rent your home back from the buyer for an agreed upon period of time while you look for a new home to buy.
Either of these contingencies makes the home seller’s process go more smoothly, and help you avoid the need for financing, but these contingencies are easier to achieve in a seller’s market when buyers are eager to make their offers as competitive as possible.
A more modern approach is skipping loans and contingencies altogether and going with a solution that gives you cash upfront to buy your new home before selling your existing one.
We’d be remiss if we didn’t mention that Orchard is one of those solutions. When you work with Orchard you won’t pay double mortgages.
Learn more about how Orchard can help you seamlessly navigate a tandem home buying and selling experience — avoiding bridge or home equity loans altogether.