When we bought our condominium in 1987, I took some advice that served me well 15 years later. The mortgage broker who handled the purchase of our condominium, the first real estate purchase for my wife and me, said, "You are both employed at good jobs and earning good incomes. As soon as you have some equity in the home, establish a home-equity line of credit."
Several years later, we did just that. My wife had been handling the home finances, and she was paying down the mortgage aggressively, which built up a rather generous amount of equity.
I had always figured that the home equity line of credit, or HELOC, would be used in an emergency situation, something medical, perhaps.
But when we sold the condo in 2002, we used the HELOC as a "bridge loan," or swing loan.
A bridge loan is used as a down payment to avoid a contingency sale situation in which the seller and buyer agree on the terms, but the deal is dependent on the sale of the buyer's first home. If the money for the loan comes from a HELOC, it is secured by the equity in the home that is currently owned by the buyer. When the first home is sold, the loan is paid back.
Separate bridge loans are available on the market, but they typically carry much higher interest rates than that of a HELOC.
Using our equity for anything at all was a first for us and contrary to the financial rules we had established many years before. Those rules included staying out of debt. Over the years, we paid cash for everything except for one automobile, which had a modest and affordable payment. There was no credit card debt at all, no student loans to pay back, no other debt. Vacations, even one to Europe, were paid for in cash.
But in 2002, the bridge loan was our savior, and we used it to buy our move-up home in a hot seller's market. Just a few months before we bought our new home, a friend selling his house in Irvine was entertaining competing bids from two buyers who waited in their cars in the street while their agents rotated in and out of the home presenting counter offers. He told me that the rapid-fire offers earned him about $10,000 every 15 minutes until one of the bidders bowed out.
In other words, in a hot market, you can forget about getting a seller to agree to a contingency sale.
Orange County, however, is still a buyer's market and contingency sales are more common because sellers are often desperate and will entertain such offers.
But buyers may have reasons to want to speed up the sales process without a contingency and would use a bridge loan to close the deal. Popular reasons include buyers who are relocating, buyers who want their young children to start school in a better district, or simply the need for more space.
For my wife and me, the couple with no debt, we faced the thought of juggling three notes: the existing first mortgage, the bridge loan and the new mortgage.
Because the market was hot, I planned for a quick sale of our condominium and planned the initial draw from HELOC accordingly. At the last moment, though, I hesitated and decided that it was in our best interests to plan for the sale of our first home, the condo, to take 60 days.
That turned out to be a wise move as the deal was sealed in 45 days.
Swing loans should be carefully considered as they have the potential to become a tremendous financial burden if not properly planned and executed. It is also important to check with your broker on the tax implications of a HELOC as a swing loan as it may not qualify for any deductions.
With proper planning, however, a bridge loan could be the best way to move up.
STEVE SMITH is a Costa Mesa resident and a freelance writer. Send column ideas to email@example.com.