What do you think of bridge loans?

[TBH]

I've posted before about my current plan to buy a new house before selling our old one. I know this is an unpopular idea, but I think we can do it.

After looking into many options (FHA loan which wouldn't require us to borrow equity from current house, home equity loan with fixed rate, refinancing current house and taking equity out to buy new house) we decided on a HELOC. We decided this because we won't have to borrow the money and start making payments until we find the new house. Also, the lock-in rate for the HELOC was significantly lower than the fixed rate for the home-equity loan. Refinancing the house was undesirable because of closing costs and because it would take longer to close on the new loan and we wanted to be able to buy something relatively soon.

But yesterday I stopped into my local bank for something else and ended up talking to the bank president (very small bank) about their mortgage options. He thought I should think about getting a bridge loan. He said with a bridge loan, the bank would put a lien on both the old house and the new house, and we'd borrow the entire purchase price of the new house and make interest only payments on that. I'd still have just the first mortgage on the current house. When we sold the old house, we'd get a traditional 30-year fixed rate loan on the new house. If we couldn't sell the old house quickly and decided to keep it to rent out, we could refinance to get rid of the bridge loan and be left with two 30-year fixed rate loans, one on each house.

He said he thought the biggest risk to me was that the rates might go up on 30 year fixed loans before my old house sold. Obviously the biggest risk is that we wouldn't be able to make payments and we'd lose both houses, but I think that's highly unlikely.

Some stuff I read online warned about bridge loans, saying the rates and fees were often higher than other loans, but he said the total fees would be about $400 and we could get a fixed rate on the bridge loan that would be about 5%.

This all sounds intriguing but I'm nervous about getting an unfamiliar loan product. It seems like I wouldn't be borrowing more money, really.

What do you think?

[TBH]

PS. Some numbers, which I know some of you will want.

Current house:
Bought for $70,000 5 years ago. Put maybe $30,000 into it. Currently owe $44,000, a 5.25 fixed 20-year loan, payments $580 per month. Bank assessed it at $168,000 when we did the HELOC last month. Our realtor wants to list it for $140,000. I will be pleasantly surprised if we get more than $125,000 in the current climate. If we can't sell within 6 months we'll take it off the market and rent it. We think we could get around $1000 a month in rent.

Future house:
We're looking for something costing between $225K and $275K. We'd probably put 20% down. If we find a good house costing up to $325K with a nice rental unit in addition to the main living space (not uncommon in our area) we'd do that too.

Currently have about $40,000 in cash savings, but $9000 is set aside to pay taxes (I'm self-employed so I have to save a lot of $$ for taxes).

Household income is around $80,000, altho it fluctuates a bit. We have no other debt and own one very old, very paid off car.

[swanson719]

The new mortgage payment is going to be roughly $1,500 on a 5.0% 30 year fixed once you factor in insurance and taxes. That still leaves you approximately $62,000 after the mortgage is paid. Another years worth of mortgage at your current $580 is $7,000. So you're down to $55,000, with 14 months worth of payments in savings. So you could feasibly handle both mortgage payments for 2 years on a worst case scenario, if you couldn't get it rented out. I think it's pretty safe to say you won't lose either house.

If you would be able to keep your current house and rent it out at $1,000 a month as opposed to selling it for $125,000 why not keep it as a rental? You'd be making $5,000 a year on it over the cost of the mortgage. I mean, that's if you're willing to deal with the head-ache of being a land-lord, which it sounds as if your not opposed to.

As to the bridge loan aspect, I would steer clear of that. The main reason being making interest only payments on the new house. Albeit for only a few months, but that interest only would probably be more than enough to cover closing costs on a refinance. Twas I in your shoes, I'd figure out how much you'd need to cover the down-payment on your new house, then take that out in a HELOC. That conserves your EF, get's you into the new house, and then when the house sells, you take the gain from that and dump it into principle on the new house, while maintaining the HELOC at a low interest fixed rate. That will lower your principle on the house by $70,000 roughly, effectively knocking off about 15 years from the 30 year mortgage. Then aggressively pay down the HELOC, which shouldn't be more than $55K if you get $275K of a house and put the 20% down. If you put $1000 a month on the HELOC it would be paid off in no more than 5 years. So you would be able to get into your new house, be carrying $2,500 a month in payments, live on $50,000 for 5 years, and then 10 years after that have the house paid off. It changes your lifestyle for the next 5 years, but knocks 15 years off the mortgage. If you continue to pay that extra $1000 a month in the HELOC as extra principle after the HELOC is gone, it knocks another 4 years off the mortgage. You would end up with a mortgage for roughly 11 years as opposed to 30 in this scenario.

[MonkeyMama]

If you need a bridge loan to do it - you can't afford it.

Bridge loan is a scary product. We considered it when we did own 2 homes briefly (& why I already advise against owning 2 homes - if you can't afford it for a LONG time - and I certainly advise against a bridge loan).

My understanding was a bridge loan was only for a few months - very high interest rate. So basically, very expensive AND you are kind of screwed if you can't sell the old place in their time frame. I admit I don't remember much of the details except we decided it was insane, and to avoid the possibility.

Plus you said if you can't sell you would rent. How would a bridge loan play into that?

I mean this does not sound like a "traditional bridge loan" so I don't even know if it's the proper term. It's definitely not the same product we looked at. Ours was to borrow the down payment on our new home and to pay it back when the old home sold. But in the grand scheme of things sounds like something to be avoided, no matter how structured. I am not sure you would be free to rent out the property and keep it if you could not sell. That would be my main concern (what are the consequences if it doesn't sell? in their time frame?)

[MonkeyMama]

FWIW, we refied and pulled out the down payment from our first home, for the second home. This really makes the most sense, and clearly you are in a spot to do this. The HELOC has got to be better than the bridge loan. Less strings tied to it and lower interest rate, for sure.

I'd still advise selling first, of course.

[TBH]

Thanks, Swanson and MM.

Swanson, if the HELOC was on our old house, how could we keep it when we sold that house? Can you just tell your bank, hey, attach that mortgage to this other house instead? I've never heard of that.

Also, the biggest flaw in this plan is that our EF is going to be depleted no matter how we do this. The HELOC covers the down payment, but the EF has to cover closing costs (I'm planning for about $12,000), and also mortgage payments on the old house until we sell it or rent it. It will also have to cover the move (we're moving less than 2 miles, though, and will do much of it ourselves) and any small fix-it things the new house needs before we can move in. I am saving like mad right now trying to beef up the EF, but I would feel better about all this if we had, say $10,000 more in there right now.

Also, renting the old house for $1000 will barely cover the mortgage, because we'll have to pay $580 per month on the first mortgage, plus whatever we'll owe monthly on the HELOC. If we decided to keep it and rent it we'd probably refi it so we'd have one payment. We plan on owing about $100K on it, tops, when we have borrowed equity for the down payment on the new house.

We'd be willing to be landlords out of necessity, but we don't want to be landlords long-term.

If we did do the bridge loan, the banker guy said that if we decided to keep both houses, we could get more traditional 30-year fixed loans on both houses and get rid of the bridge loan.

I don't know. I hate the idea of the HELOC because it's not a fixed rate, but the bridge loan sounds too scary because of the interest-only thing and also the idea of having one bank have liens on two houses that I own.

[swanson719]

You have a point with the HELOC being attached to the property. Didn't think about that. It's also not a fixed rate, which would be a problem as well. If you do the HELOC then and you owe the $100K and walk away with $125K, and pay $12K in closing costs, you're only making $13K in principle after it's all said and done, and then you'd pretty much be using that to put your EF back where it was before the closing costs. Basically, selling this house covers your down-payment on your next then. You're not making any money renting it either with the HELOC, and there isn't a big enough tax break on a rental to justify it either. I really hate to see you guys go from having $44K in debt to $220K. It's your money, but if you were to pay your current mortgage at the same amount you'd spend on the new one each month, it would be paid off in a little over 3 years, and you'd have absolutely no debt. A bigger house just isn't worth giving up being debt free as far as I'm concerned.

[Hot dog]

When my house didnt sell as planned I ended up getting a 2nd mortgage to pay the 20% down payment and planned to pay it off when house sold. We have now been landlords for 3 years and still learning. we have paid off the 2nd and I guess will continue on that path. Once the rental is paid off all that money will go toward our house and then retirement. It has worked out. Stressful at times but no matter how much I worry whenever I put it in the paper someone wants to rent it and we have had two different tenants that both took good care of the house. We are still learning the business part of it though. Ours is only three miles away from our new house.

[TBH]

Swanson, that's it exactly. The equity in this house will just cover our down payment and closing costs on the new house. We'd be paying the closing costs out of our EF and replenishing the EF when the old house sells. If we didn't sell it, we'd have to figure out some other way to re-fund the EF quickly (save like crazy, pick up more work, etc).

I totally get that it would be better for us financially to stay in this house. In this house, we could get by with only one of us working, which is a plus in this economy and especially good for us since my health is iffy. In 2007 I got sick and we were both out of work for several weeks (I was too sick to work OR take care of our kid, so we both had to be out of work). This house has been a great thing for us financially. We have been able to pay for 5 years of daycare, save for college and retirement, and we've been able to travel frequently and take more risks with our careers because of our low fixed expenses. And when I got sick, there was never a moment when we thought we wouldn't be able to weather it financially.

But when I think about not moving I get all kinds of dramatic. Living in this house is KILLING ME. I know, I know, it's really not killing me and I am very lucky to have this affordable house.

I know what I should do (stay here) but I don't know yet what I'm going to do.

[zetta]

Have you considered putting in an offer on the new house that contains a contingency clause on the old house? What this means is that you don't close on the new house until after you find a buyer and close on the old house. I think this used to be very common before the housing bubble.