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Bridge Over the River Equity

Dan Smith - Tuesday, June 20, 2017

This month, I wanted to follow up on several recent inquiries regarding “bridge loans” and what is best practice, and how do they work. For those of you who are unfamiliar, the term “bridge loan” refer to a situations where someone is trying to use the equity in their current home, to buy another home, before their current home sells. In a fast moving seller’s market like the one we are in, understanding how this all might work can be critical. So let’s take a closer look…

The first thing I generally ask someone in this situation is, “Is you current home listed for sale yet?” If the answer is “No,” then typically the least expensive way to access your current home equity is by taking out a Home Equity Line of credit (HELOC), prior to listing. Most banks and credit unions will allow you to access up to 90% of the appraised value of your home. However, you probably don’t want to mention the word “bridge” when arranging this loan. A true “bridge loan” has the same terms generally as a HELOC – but the bank will cut you off at 80% and charge at least a 1% fee. Meanwhile, most HELOCs charge little of no fees/costs up front. If they bother to ask you the intended purpose, you can honestly say you are looking at making some additional investments. Or you can just tell them you haven’t decided quite yet. That said, you will likely have to pay an “early termination fee” of $350-$500 for any HELOC closed in the first three years – when the current home sells.

The other advantage of a HELOC is that the payments are “interest only”. The rate is usually based on the “prime” interest rate (currently 4%), plus a margin of 0% to 2%. In cases where you have a current first mortgage, it may even make sense to roll that loan into the HELOC as well, for this very reason. By eliminating the principal, taxes and insurance portion of your payment, it will be much easier to carry the cost of two homes, for whatever time it may take to sell the current home. A HELOC can also be used to purchase the new home, though you would likely want to use a different bank or credit union, for the reasons listed above. It all depends on how far you need or are willing to stretch your budget, in order to get the new home you are after. The advantages of this latter strategy are that there is little or no upfront expense, and it provides the least expensive carrying costs (overall payment), during the interim period.

In some cases, a true bridge loan cannot be avoided. However, there are variations of this type of loan as well. I have arranged a “blanket loan” successfully several times in the past, when a single bridge loan would not have filled the gap. By that I mean, being limited to 80% of the current home’s value may leave many people short of funds. But sometimes the math works better, if the bank can make an 80% loan against both the old and the new home! In a few cases, my clients have owned several properties that could all be “collateralized” with a single bridge loan from the bank, to achieve the desired result. Hence the word “blanket”!

Other options that may work in place of those listed above include the use of a margin account. Many clients I work with have healthy portfolios, but don’t wish to liquidate them outright for this purpose. However, in some case the rate charged on a margin account is lower than that of a HELOC. Many folks also are unaware that they can borrower from a 401K (paying themselves back the interest charged), and/or a whole life insurance policy. And while I am not a CPA, my understanding is that funds liquidated from an IRA, but replaced within 60 days, do not have any tax penalty ramifications either. So just be sure to check with your plan administrator and your CPA, before attempting this maneuver.

Lastly, there are many people who can qualify for the new home purchase, without the sale of their current home. But there is a trap that most lenders set, which you should avoid. As an example, assume you know you will net approximately $100,000 from the sale of your current home. Meanwhile, you have enough in savings to comfortably make a 10% down payment on the new home. Most lenders will be happy to make you a 90% loan on the new home, knowing full well that when the current home sells, you will likely come back to refinance and get a lower payment. They earn two sets of commissions, by steering you in this direction. Instead, when you purchase the new home do the following. Get a first mortgage amount based upon what you would have needed using the $100,000 from the sale of the old home. Then get a purchase money HELOC 2nd for the $100,000, to close simultaneously with the new first mortgage. That way, when the current home sells, you simply pay the HELOC down to $0, and are left with the mortgage you needed to begin with. This not only avoids paying two sets of fees and commissions, but limits your exposure to “rate risk” down the road! 

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