A Closer Look at Bridge Loans
A bridge loan, ideally referred to as a bridge loan enables you to finance a new house before selling your current one. It offers an excellent way to give you an edge, given how tight the housing market is nowadays, but only if you can afford them. A bridge loan calls for 20 percent equity in your current home, involves high fees and interest rates and is usually best in places where houses sell fast. Let us delve further in the realm of bridge loans.
In a perfect world, your property would be under contract to sell before making an offer on a new one. The money from the sale act as down payment for the next and without much hassle, you are in a new home. However, we do not reside in a perfect world and that’s why some people go for bridge loans.
A bridge loan can give you more time between transactions, by giving you access to your home equity before selling. By doing this, the loan can help you avoid taking the contingent offer route on the property that you are looking into. Contingent offers allow you to get out of a contract if your current house does not sell, and so, it is easy to see why home sellers dislike them. In a seller’s market, people who come with conditions are bound to be unable to compete against offers from house buyers that already have the money.
So, how do bridge loans really work?
When you decide to apply for a bridge loan, you should expect similar credit and debt to income requirements as a mortgage. Most lenders will not go beyond an 80 percent loan to value ratio, according to Jim McBride, of FHA Loan Advisors. As such, you will need to have 20 percent and above equity in your property for a bridge loan to be an option.
These loans are usually used in one of two ways:
- The first is as a means to pay off your existing mortgage, thus putting any excess towards the new down payment.
- The second is another mortgage which becomes the down payment for the new property.
First Example: Paying Off The Mortage and Down Payment
Let us assume that your current property is worth $300K and you owe $200k on a mortgage. A bridge loan for 80 percent of the property’s value, which is $240K pays off the current loan with $40K to spare. If the bridge loan fees and closing costs are $5k, then you will be left with $35K to put as a down payment on your new house.
Second Example: Second Mortgage
Let us assume again that your home is worth $300K. With $200K on the mortgage, you will have $100K in equity. A bridge loan for 80 percent of your home equity will give $80K for applying towards buying your next house.
Both of these cases assume that your old home sells, enabling you to pay off the bridge loan and interest relatively quickly. If it does not sell in time, then you will owe the entire amount of the loan on top of your second mortgage. This can be quite problematic and could cause financial stress or force you to default.
The Pros and Cons of Bridge Loans
The Pros Of A Commercial Bridge Loan
- Payments are usually interest only, or deferred until you sell your new home.
- It is possible to make an offer on a property without a sale contingency.
The Cons Of A Commercial Bridge Loan
- You will pay a high-interest rate. The lender can even utilize a variable prime rate that goes high with time.
- You may own two properties, with two mortgages for a while.
- You may be forced to pay for an appraisal, fees and closing costs.
- You are limited to 80 percent loan to value ratio, and this needs more than 20 percent equity in order to get adequate money for the property that you want.
If you find yourself in the following situations, then a bridge loan can help pave the way:
- Sellers in your location will not accept contingent offers.
- You are certain that your home will sell, but want to secure a new one before listing it.
- You cannot afford a down payment without the funds from your current property.
- Closing on your current home is scheduled after the closing date of your new one.
According to McBride, FHA Loan Advisors made more bridge loans in 2018 than any other time since 2008. The renewed popularity of bridge loans shows how useful they can be for individuals who are looking to win contracts in a competitive housing market.
How Do You Find a Bridge Loan Mortgage Lender
Well, the best place to start is local. Instead of looking for a credit union or bank, consider using the internet to look for a reputable bridge loan lender. This is advice from McBride, even though he is biased as FHA Loan Advisors are the best in the industry.
Also, avoid collateral based lenders who advertise fast cash on the internet. They might offer bridge loans, but you are going to pay higher interest rates compared to conventional lenders and they may not even be reputable.
Alternatives To Bridge Loans
If you are unable to find a bridge loan lender or feel that it’s a risky move, do not give up hope. There are alternatives that are more affordable and may be easier to acquire. However, it is important to keep in mind that all will require you to have multiple mortgages until your home sells.
HELOC Loans (Home Equity Line of Credit): This is a second mortgage that allows you to access your home equity similar to a bridge loan. However, you will get a better interest rate, have more time to pay it back and pay lower closing costs. A HELOC ideally enables you to utilize the funds in other ways such as making home improvements to increase your home value.
Note that you cannot get a HELOC on a property that is for sale and so, this alternative calls for action in advance. You will ideally want to avoid HELOCs that have prepayment fees as they might cut into your profits if your house happens to sell in a timely manner.