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Madison County Structures
So. You’re going to do it.
No contingency, no try for first right of refusal... you’re going to buy the new house with a bridge loan.
The classic, old-fashioned bridge arrangement is to extract some (or all) of the equity from your current home by taking out a second mortgage of some kind, and use those proceeds as a down payment together with a purchase mortgage to buy the new place.
You’ll have to qualify for the sum of the payments on your existing first mortgage, the new, equity-extracting second, and the purchase mortgage. In the brave new world of underwriting by computer, it’s easier to approve these classics than ever: if you have good credit, Fannie's Marvelous Money Machine will tolerate total payments in excess of 60% of your gross income.
The equity-extracting leg of the deal is a bank product, usually a line of credit. Any loan recorded against your house after the first mortgage is a “second mortgage”, but in usage common to bankers, a second mortgage is different from a line of credit. Seconds are usually fixed-rate, fee heavy, and amortized over a maximum of 15-20 years, which means a large-ish minimum payment.
Lines of credit are typically low- or no-fee, floating-rate (tied to prime, which can be exciting), and depending on how much money you need relative to the value of your home, you may be able to negotiate interest-only payments. For short-term loans, like bridges, the interest rate is not so important as minimizing transaction costs and payments.
The general attitude at banks regarding lines of credit: “When would you like us to put the money in your account?” Answer: just before purchase, thank you; I don’t want to pay interest until I need the money.
However, don’t wait too long to sign the documents: any non-purchase loan on a primary residence triggers the Federally-mandated “three-day right of recision”, the un-waivable consumer protection under which the bank cannot give you the bridge proceeds until the fourth business day after you sign the loan documents.
Before embarking on the classic bridge, have someone help you take a financial inventory, looking for “self-bridging” possibilities. You’ve got more pockets than you think.
First, examine your financial assets -- especially assets against which you can borrow. (If you’ve got enough cash for a bridge -- mazeltov! -- there is no reason to read the following except to see how the little people live.)
If you have a substantial securities portfolio, the cheapest bridge loan in the world is a margin loan. Though you don’t ever want to borrow so much that a stock market swoon would expose you to a collateral call, borrowing up to 30-40% of your portfolio is a fee-free, next-day transaction at a rate often below prime. For reasons best known to Fannie and to God, the payments on margin loans are not used in underwriting ratios.
Another pocket: borrowing against your 401K. Don’t do it if there is the slightest prospect of switching jobs, as 401K loans are callable upon separation; and don't do it if your 401K requires short-term amortization (the payments will be too big for comfort, even though they would be to yourself). There are other retirement vehicles against which you can borrow (some of the mysterious self-directed plans), but generally, you can’t borrow against an IRA.
Don’t ever, ever, ever let somebody talk you into liquidating a retirement account.
The last inquiry to make before applying for a market bridge: check with family. There may be a relative with assets and limited income who would love to earn a percent or two over prime from you, instead of having you waste such riches on a bank.
Now we’re done with all the simple (!) bridges.
The “Madison County” program involves bridges, as in plural (clients’ blank faces have yet to stop me from dead-pan introduction by this title). It is often a good idea to execute two or more bridge loans: the cheapest extraction loans are usually available up to 80% of the value of your current home. If this limitation leaves you short of cash to buy, then fill the gap by buying with a new first mortgage tailor-made for the long term and a purchase second mortgage (bridge loan number two), the second to be collapsed with the sales proceeds from your existing home.
By the end of some Madison County planning sessions, clients look less like Streep and Eastwood than Alec Guinness in River Kwai, after the steel box. The multiple bridges try patience, but they can save a ton of money.
But, what if you don’t have the income to qualify for a classic? The heart, but not the scratch?
If you have enough equity in your current home, some banks will loan you the entire purchase price of the new home, and secure the loan with liens on both the new home and your current one. “Enough” equity for this cross-collateralized structure: (I wouldn’t try this one at home by yourself) if your equity is equal to or greater than 20% of the sum of the two market values.
When your house sells, the proceeds will pay off part of the acquisition loan, and the rest will be retired with a permanent mortgage on the new place. The only disadvantages of a single-piece acquisition loan: usually a one-percent loan fee, and slightly higher costs on the ultimate mortgage (which then would be a refinance loan).
Two overriding rules of bridging, no matter how you do it: credit is so easy that the market will loan you enough money to ruin you; and unless you have a pile of cash, you’ll have to borrow the entire purchase price of the new home.
The two rules occasionally interact.
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