Buying a Home? Dave Ramsey Says to Avoid This Loan at All Costs
- Buying a home before selling your current one can be convenient if you can manage the expense.
- A bridge loan could make that easier, but it has some drawbacks.
- Bridge loans often have higher interest rates, and it can be a big expense to juggle if your home doesn't sell fast enough.
It's advice worth taking.
So you're ready to buy a home -- perhaps upsize to a larger property or move to a neighborhood with more restaurants and amenities. If you're currently renting, you may have spent the past few years socking away funds to serve as a down payment on that new home. But if you're a current homeowner, your down payment funds for a new home may be tied up in your existing home.
It's common for property owners to build up home equity over time, which makes it possible to spend more on another home. So, say you bought your home for $300,000 and took out a $240,000 mortgage. But now your home is worth $400,000 and you only owe $200,000 on your home loan. That means you're looking at a $200,000 profit when you sell your home (minus real estate agent fees and transfer taxes, if they apply to you). And that profit can serve as a down payment for a new home.
But what if you find a new home to buy before your current one sells? It's a situation many buyers find themselves in, and a bridge loan might seem like a good solution. But financial expert Dave Ramsey warns that it's important to proceed with caution when taking out a bridge loan, and that's advice you may want to follow.
What is a bridge loan?
A bridge loan is a short-term loan you can use for situations such as the one above -- needing to make a down payment on a home when your money is tied up until your existing home sells.
Typically, you'll need to repay a bridge loan in six months or a year, and usually, your existing home will be used as collateral for that loan. (Collateral is an item of value you can use to get a loan, like a house or car. If you don't pay your debt, the lender can take your collateral to get back their money.)
The upside of getting a bridge loan
With a bridge loan, you get more options for purchasing a home without having to worry about selling your current one. That could take a lot of stress off of your plate, especially in today's real estate market, where buyer competition is fierce.
What home buyers will often do is make an offer to buy a home that's contingent on the sale of their existing home. But in today's market, buyers with that sort of contingency might easily see their offers ignored in favor of offers with no such contingency. A bridge loan could make it possible to buy a new home unencumbered.
The downside of getting a bridge loan
There's a reason Ramsey is against bridge loans. First, they tend to come with high interest rates. And if you're late paying your loan, the fees can be substantial.
Now in a normal housing market, a bridge loan may be riskier than it is today. That's because it's common for homes to sit on the market for months, and you'd probably need your home to sell to repay your bridge loan.
But in today's real estate market where inventory is sorely lacking, the reality is that your home is less likely to sit on the market without a buyer unless there's something glaringly wrong with it, or unless you've priced it unreasonably high. As such, you can argue that you're less likely to be late repaying a bridge loan right now due to the state of the market -- but it's still important to recognize the risks involved.
Be careful when buying and selling
Buying a home before your current home sells is a risky prospect that Ramsey advises against. And when you take out a bridge loan, that's what you're doing -- moving forward with a home purchase before you've sold your existing home.
If that's a route you're comfortable taking, then a bridge loan could help you present yourself as a stronger buyer. But be sure to take Ramsey's warnings to heart before committing to that financing.
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