6 Steps to Using a HELOC as a Bridge Loan To Buy Another Property
One of life’s most complex juggling acts is selling one house and buying another.
Do you sell first and use the proceeds to buy? What about the gap in the middle?
Or do you make a contingent offer that has little hope of being accepted by a nervous seller?
What if there were a way to buy before you sell without a contingency? Can a home equity line of credit, or HELOC, be your down payment on the new home?
Is It Okay To Use a HELOC as a Bridge Loan?
First, know that bridge financing is not the intended purpose of a HELOC. Typically, HELOC lenders want you to have the loan for years to earn interest income.
That being said, many lenders do not have a rule about how long you have your HELOC. So in theory, you could open a HELOC and pay it off in a few months when you sell the home.
Ask your HELOC lender about any penalties or fees for closing the HELOC early. You may even want to run your plan by the lender to make sure you are not violating their terms.
How To Use a HELOC as a Bridge Loan
Assuming all is above board with your lender, here’s how the HELOC-as-bridge strategy plays out.
1. Estimate how much money you’ll need down plus closing costs on the new home.
2. Get a pre-approval for a new home including the HELOC payment. Make sure you qualify with all loans.
3. Open a HELOC for the correct amount.
4. Make a non-contingent offer on a house.
5. Close on the new home using HELOC proceeds.
6. Sell your current home, which pays off the primary mortgage and HELOC.
Let’s look at each step in more detail.
1. Estimate Your HELOC amount
Determine the down payment you’d like to make on your new home.
If it’s a $500,000 home and you want to make a 20% down payment, you’ll need $100,000. But your costs could be higher.
Closing costs on the loan will be around 2-4% of the loan amount. In this case, you’ll need an additional $12,000 or so on a $400,000 loan.
Make sure you have adequate equity in your current home. Some HELOC lenders allow up to 100% loan-to-value, but some cut off at 80% or 90%. For example, you may need $150,000 in equity to tap the $112,000 needed in this example.
Remember to leave about 8-10% equity in the home after the HELOC for agent commissions and other home sale costs. Here’s an example.
Current home value | $400,000 |
Current mortgage | $200,000 |
Down payment needed for new home | $100,000 |
Closing costs on new mortgage | $12,000 |
Remaining equity | $88,000 (22%) |
In this example, the homeowner is leaving enough equity intact to pay fees associated with selling the home.
2. Get a Pre-Approval For the New Home
Tell your loan officer about your new HELOC. You will have to qualify for the new home including:
Your current first mortgage
The new HELOC
The loan on the new home
The lender will qualify you assuming you won’t sell the home. This is the only way to make a non-contingent offer. The lender will estimate the full payment for the HELOC for qualification purposes.
Your lender will likely “hit you with” a HELOC payment assuming current rates. HELOCs are based on the prime rate as published by the Wall Street Journal. For example, a “prime plus zero” HELOC of $112,000 would be $793 per month if the current prime rate were 8.5%.
Payment | |
Current mortgage | $2,000 |
HELOC | $793 |
New mortgage | $2,200 |
Total | $4,993 |
Your current home adds a significant amount to your debt-to-income ratios for the new loan. Make sure you qualify for the new home before taking out the HELOC.
3. Open The HELOC
Armed with the knowledge above, open the HELOC in the correct amount. It’s a good idea to get more than you need. You pay interest only on the amount borrowed.
4. Make a Non-Contingent Offer
Now that you have your down payment in-hand, make an offer that is not contingent on selling your current home.
This can certainly make a homebuyer anxious. If your current home doesn’t sell, you may be strapped for cash until it does. You’ll have to pay for two houses.
And, you can’t back out of the new home purchase because your home doesn’t sell. Tread carefully here and make sure there is high demand for your home.
5. Close on the New Home
Complete the loan process and close on the new home. Tap your HELOC funds at least a few days before closing. Not too early: you pay interest on whatever you have borrowed.
6. Sell Your Previous Home
Hopefully, your home sells quickly after closing on the new home at the expected price. If your calculations are correct, the home sale pays off the first mortgage and HELOC, plus covers agent commissions and other costs. You’ve done it: you used a HELOC as a bridge loan.
Bridge Loan HELOC Alternatives
Get a HELOC on the new property: Lenders may allow you to get an 80% first mortgage and 10% second mortgage on the property you’re buying. When you sell your current home, pay off the 10% second mortgage. This may not require a contingent offer if you had adequate savings for 10% down.
Use savings: You could tap savings or investment accounts and reimburse yourself when your home sells.
Mortgage recast: When your current home sells, make a lump-sum payment on the new loan. The lender may be able to adjust your payment based on the new lower balance and even remove private mortgage insurance.
Bridge loan services: There are many services in the market that will front the down payment for the new home. Some services charge a fee, others simply do it for the agent commissions and mortgage fees. Shop around for your best option.
Start By Getting a HELOC Quote
A good place to start is by getting a HELOC quote. Run your scenario by an experienced lender to see if this strategy can work for you.
