Selling and buying a house? Bridge loans and other solutions

Updated by Craig Berry

In a perfect world, you would sell your current home and buy your new home on the same day, moving seamlessly from one mortgage to the next. While this smooth transition sometimes works for certain repeat home buyers, it's not always as easy as 1-2-3.

Many homeowners find they need to secure a financing option that allows them to buy their next home prior to the sale of their existing home.

Selling and buying a home: money sources

You have decided it's time for your "move-up" home. Or, perhaps it's time to downsize your existing home. For any number of other reasons, it's definitely time for a change that involves buying your next home.

Unlike when you purchased your first home, however, this time you have a home you need to sell. Today's underwriting guidelines and documentation requirements may make buying a home more challenging that it was the last time you entered the real estate market.

Now more than ever before, it is imperative that you have proper expectations, as well as a thorough understanding of the options available to you.

Wondering, "How do I sell my house and buy a new one?" In a perfect world, you would buy a new home, move, then sell your existing home. Unless you are fortunate enough to have the financial capability to pay for two mortgages at once, you may need to pursue one or more of the four options below:

1. Bridge loans

So what is a bridge loan and how does it work? Bridge loans are short-term loans intended to bridge the funding gaps for home buyers. You are effectively using your current home as collateral for the down payment toward your new home.

Bridge loans are secured by your existing home, tend to be 6 -- 12 months in length, and come with higher interest rates than is typical with many traditional home loans.

While bridge loans were quite popular at one time, they are much rarer than they used to be. Homeowners generally need to have substantial home equity, excellent credit and income to qualify for a bridge loan today.

2. Gift funds

If you have relatives willing to provide you with some of the cash to make the transition to your new home, gift funds can be a great solution to your move-up home buyer dilemma. Your relatives must sign a gift letter and provide some basic documentation.

Gift fund underwriting requirements have loosened throughout the years. Not only is there no limit to the amount of gift funds someone can give you when buying a house, there is no longer a requirement of having your own minimum investment in the property.

3. Your home's equity

Assuming you have the equity position in your current home, a great alternative to bridging the gap when buying a new home is to pull equity from your existing home.

Homeowners generally have two options when using their existing home equity: cash out refinance loan or home equity loan. Both of these options involve obtaining a new mortgage loan.

A cash out refinance is exactly how it sounds. You are refinancing your existing mortgage loan, where the new mortgage loan is for a larger amount than the current loan, and you get the difference between the two loans in cash.

A home equity loan is a way for homeowners to access the equity they've built in a home. This type of loan is typically structured as either a standard home equity loan or as a line of credit, both falling under the category of a second mortgage.

Due to the additional risk associated with these types of loans, cash out refinances and second mortgages generally have tougher guidelines and more restrictions than do traditional home loans.

4. Your 401(k)

Your 401(k) funds could be a way to come up with a down payment while waiting for your existing home to sell.

The best way to use your 401(k) for a down payment is to borrow against the balance. Generally, 401(k) loans can be made in amounts that represent the larger of $10,000 or 50 percent of your plan balance, with a maximum loan size of $50,000.

Most 401(k) loans carry repayment periods of five years or less, though longer periods may be permissible for home loans involving your primary residence.

To understand the options available to you involving your 401(k), check with your employer.

A contingency offer may be safest

Making a contingency offer means you are making an offer to purchase a home with the understanding that your home must sell prior to your ability to buy. This strategy can be effective but in a hot real estate market some sellers may not be inclined to consider contingency offers.

Fortunately for home buyers who are interested in selling and buying a house at the same time, there are financing options available to facilitate the process.