Why Bridge Loans Are Frequently Used Today
Many homeowners today are concerned about the need to perform a two-phase transaction when buying a new home. This is due to their need to sell their current residences to afford the new ones. Fortunately, a bridge loan enables a homeowner to purchase a new house or commercial property before selling their existing ones.
Although most bridge loans are for a term of six months to one year, some are structured to last from two weeks to two years. In an unpredictable real estate market, it can be difficult to sell your home before you purchase a new one. Of course, you want to avoid making payments on two mortgages at the same time, if possible.
With a bridge loan, you have the benefit of a “bridge” to cover the financial gap that results from buying a new home prior to selling your existing one. These loans are also known as “bridge financing” and “swing loans.” They are frequently backed by collateral, such as your current home that you wish to sell.
Bridge loans typically have relatively high interest rates, and they often require 20 percent equity. Yet if you have the capital to repay your loan within a short time period, a bridge loan is an ideal way of funding a new home purchase.
Common similarities of all bridge loans include the following characteristics:
- Most have terms equaling six months to one year.
- These loans are usually secured by the buyer’s current home equity.
- They all include interest.
- Bridge loans do not usually include term extensions.
- In many instances, borrowers must have equity for gaining approval for a bridge loan.
As an example, you may own a home valued at $500,000 that has $300,000 on the mortgage. This will give you $200,000 in equity. The most helpful bridge loan that you can obtain is equal to approximately 80 percent of your equity. This can enable you to have $160,000 toward making a down payment on your new residence.
Important Pros and Cons of Bridge Loans
Major pros and cons of bridge loans include the following features and qualities:
- Quick Cash. If you need cash quickly to buy your new home before you sell your existing residence, a bridge loan is a good solution. It enables you to make your new home purchase without any worries concerning not having sold your current residence. It also prevents you from having to seek other sources of funding to transact the purchase of your next home.
- Relocation Expenses. If you need to move to a new city or state quickly due to a job promotion or a change in employment, a bridge loan can help. This loan can help pay your relocation expenses until your current home is sold. This can be very reassuring to you and your entire household, especially if your move must be planned on short notice.
- Delayed Monthly Payments. Frequently, bridge loans do not require payments during the initial months following their issuance. This provides the homeowner with the option to make these early repayments according to their incoming cash flow. This also enables the borrower to make monthly loan payments after their former home sells.
- No Sale Contingency. When you acquire a bridge loan, you can place an offer on your new dream house free of any sale contingency. This helps ensure that your offer will be honored and often favored, making you the owner of your desired new home.
- Appraisal Costs. When you receive a bridge loan, you may need to pay for a home appraisal. This can require the use of part of your loan, although you had initially planned to use the entire loan amount to purchase your new residence.
- Closing Costs and Fees. You will be required to pay for closing costs and fees, which will reduce the amount of your funding that you can use for purchasing your new house. If there are any unexpected extra fees associated with buying your new property, this may be somewhat stressful to resolve.
- Two Mortgages. For a limited time after purchasing your new home property, you may own two homes. This means that you will owe two different mortgage payments each month. This can cause a strain on your budget soon after acquiring your new residence. Especially since there are often at least minor initial home updates that you want to make on your new home, it can be a burden to have two mortgage payments to make simultaneously.
- Limit of 80 Percent LTV. With a bridge loan, you are limited to 80 percent loan-to-value (LTV). This means that upwards of 20 percent equity is needed to equal sufficient capital to buy your new residence.
- High Interest Rates. You will be charge relatively high interest rates on your bridge loan. In addition, your lending agent may use a variable prime rate, which will increase over time.
- More Costly than Home Equity Loans. A bridge loan is more expensive than a home equity loan. Home equity loans are long-term with repayment time allowances that can range from five to 20 years. If you gain approval for this type of loan, the interest rates will most likely be lower than the interest charged for a bridge loan. Yet home equity loans can be somewhat risky.
If your existing home does not sell, you may need to make monthly payments on three loans simultaneously: your first home mortgage, your new mortgage and your home equity loan. If you have lots of equity in your existing home property, a home equity loan can be a safer choice. Yet if you have only limited equity in your current home, a bridge loan is most likely a better option.
When is a Bridge Loan the Ideal Option for You?
Bridge loans are not the ideal solution for everyone who is buying a new home. Yet for anyone who wants to buy their dream home before they have sold their current residence, a bridge loan can be quite helpful. More situations for which obtaining a bridge loan is an excellent choice include the following:
- You have confidence that your existing residence will sell, but you want to locate and secure a new home before selling your former one.
- Home sellers in your locale do not accept contingency offers on their properties.
- Your current home is being sold, but the closing date is after the closing date for your new residence.
Work with an Experienced Bridge Loan Lender
When shopping for a bridge loan, be sure that you engage the services of the best lender. These loans are somewhat of a niche funding product that very few banks offer to customers. It is helpful to be aware that lender requirements can be flexible concerning these loans. Some lending agents do not require a minimum FICO score or a specified debt-to-income ratio.
Financial advisors recommend shopping for an experienced, respected lender who offers bridge loans. If possible, work with a lending agent in your local area. Search for reviews of this lender, and ask your business associates, family and friends for referrals to any local lending services that they have used.
Be sure to determine lenders’ rates and terms before signing any agreements. Also, ask all potential lending agents if they can offer extensions if your home does not sell as quickly as you expect. Take adequate time to compare loan requirements and lending policies carefully. In addition, remember that a loan with the best rate will be of the most help to you.
Even the best lenders may use a variable prime rate for your bridge loan. Be aware that this may raise your interest rate over time. It is true that this is a short-term loan, so you will be making repayments within a reasonable amount of time. Yet you should consider the fact that your home may not sell during the six to twelve-month term of your loan.
This may cause some financial issues for you in making regular loan repayments. However, most people who make use of bridge loans consider the fast approval and funding of these loans sufficiently advantageous to make up for the expense of higher interest rates.
If you have confidence in your existing home selling relatively quickly, a bridge loan can be an ideal choice for meeting your needs. If you are relocating, it can bridge the time gap from the time you leave your current home until you purchase and move into your new residence.
This loan can be especially helpful for “bridging the gap” between the time you buy a new home and sell your current residence. You can make a smooth transition from your old to your new home without feeling any financial crunch. This short-term loan is designed to enable you to make these changes in your living situation without disrupting your entire lifestyle or depleting your finances.
Just ensure that the lender who you choose to work with is highly experienced, respected and accustomed to offering bridge loans to customers. By performing some due diligence to be well-informed ahead of time, you can then make the most of your short-term bridge loan. You can successfully overcome these financial gaps that could otherwise be problematic as you move forward on your path in life.