The Purpose of a Bridge Loan
A bridge loan is a short-term lending option that can “bridge the financial gap” if you want to buy a new home before your current home sells. If you, like many home buyers today, lack sufficient other funds that are readily available, a bridge loan may be your ideal choice.
Bridge loans can also provide funding for individuals or families who need to move to a new home quickly. This move may be necessary due to a job transfer or a new employment position in another city, state or region. It may also be due to a family’s need for better schools for the children or because of the need to lend support to an older relative who is ill or in need of the family’s presence.
The majority of bridge loans enable you to borrow as much as 80 percent of both the value of your current home and the value of the one that you wish to buy. Bridge loans are frequently used to cover the closing costs of a home purchase.
How to Qualify for a Bridge Loan
When you apply for a bridge loan, your lending agent will review your general financial records and credentials. These standard qualifications include the extent of your home equity, your debt-to-income ratio and your credit rating. They may also include your annual household income.
If you had a high rating when you applied for your first home mortgage, this can be a plus. If your lending agent evaluates you as a favorable applicant, you may gain loan approval relatively quickly. In fact, the approval time for bridge loans is often significantly less than the time required for gaining acceptance for a traditional mortgage.
Typical Repayment Schedules for Bridge Loans
The majority of bridge loans offer you six months to one year’s use of funding before making repayments. The easiest way for most people to repay a loan of this type is by using the capital received from selling their homes. Most bridge loans have a final due date for the complete repayment of the loan.
The method, timing and details of your repayment schedule can be arranged with your lender. Just ensure that you fully understand the procedure for making payments on your loan at the time that you gain approval.
Basic Pros and Cons of Bridge Loans
The basic pros and cons of bridge loans are as follows:
- Useful in a Seller’s Market. In a highly competitive market with many active home buyers, your application may be viewed as stronger if you have a bridge loan. Any obstacles to gaining acceptance of your buyer’s offer on a home can be eliminated if you have secured a bridge loan. This loan reassures the seller that there is a good chance that this home sale will be transacted.
- Possible Exemption from Paying PMI. If you pay at least 20 percent of your loan down payment, you can be exempt from paying private mortgage insurance (PMI). If you do not pay this initial down-payment percentage, you are required to pay for PMI, which will increase your mortgage payments.
- Rapid Financing. The approval time for qualified bridge loan applicants is often rather short. For this reason, you need not be stressed about selling your current home before purchasing your new one.
- Fast Current Home Sale. If you place your existing home on the market and it sells quickly, you may not have been able to close on another home yet. In this instance, you may need to move into temporary housing while you locate your new residence. With a bridge loan, you can avoid this inconvenient temporary move.
- Higher Interest Rates. Bridge loans are short-term funding solutions. This makes it necessary for lenders to charge higher interest rates. It is these higher rates that make offering bridge loans worthwhile and profitable for these lenders.
- Out-of-Pocket Payments. This financing option can be very helpful or essential for enabling you to buy a new home. Yet you should remember that the interest and any other fees that are charged to you as the borrower equal money out of your own pocket that you will not regain.
- Two Separate Mortgage Fees. When the bridge loan term expires, you will start making repayments on your loan while you are also paying your actual mortgage fees.
How Lenders Package Bridge Loans
There are two major ways in which lenders package bridge loans, each designed to meet different needs of the borrower:
- Hold Two Different Loans. This package lets you borrow the difference between your existing loan balance and up to 80 percent of the value of your home. The capital from your second mortgage is used for the down payment for acquiring your new home. Meanwhile, you maintain your first mortgage until you can repay the balance due after selling your current home.
- Roll Your Two Mortgages into One. Under this package plan, you secure a large loan that can equal as much as 80 percent of your existing home’s value. You then pay the balance of your first mortgage in full. Afterward, you use the second mortgage to make the down payment on your new home.
Securing a bridge loan enables you to place a contingency-free offer for the purchase of a new home. This indicates that you are prepared financially to buy this house before or without selling your current home.
In terms of interest rates and repayments of your bridge loan, if you secure a $250,000 traditional loan with a three percent interest rate, you may be charged a monthly repayment fee of about $1,050. However, if you are issued a bridge loan for $250,000 that has a two percent higher interest rate than a traditional fixed-rate loan, your monthly repayment fee could increase to approximately $1,340.
Other Important Aspects of Bridge Loans
Of course, your lender charges high interest rates on these short-term loans because it is not possible for them to make a profit from servicing your bridge loan otherwise. They will not be receiving long-term monthly payments from you, the borrower. For this reason, the lender needs to set higher interest rates initially on your loan. This makes it worthwhile for them to offer you this helpful type of short-term financing.
You will be required to pay closing costs and fees, just as you would if this loan were a standard mortgage. These fees may be administration fees, escrow, appraisal fees, title policy charges, notary fees and possibly other charges.
In addition, you will be required to pay an origination fee on your bridge loan, according to the total amount of the loan. On every point of the loan’s origination fee, you will pay approximately one percent of the total amount of your loan. Your lender will base the points of the origination fee on the specific loan package that aligns with your qualifications as a borrower.
These loan fees can seem quite reasonable. Yet remember that your bridge loan term is just for six months or one year. You will most likely be paying these charges when you acquire the new mortgage in replacement of the one that you repay in total when your current home is sold. These fees are all out-of-pocket payments that you cannot regain later.
Who is Eligible for Bridge Loan Approval?
The process of gaining approval for a bridge loan can seem somewhat different from applying for a mortgage. The advantages are, of course, that most bridge loans offer a more rapid application, approval and funding process than traditional loans provide. This enables you to receive the funding that you need to make your new home purchase.
Yet bridge loans are not the solution to short-term real estate funding for everyone. Basic weak qualifications in ratios of debt-to-income and loan-to-value as well as a poor credit history, score and FICO score all can have a strong impact on your approval for this type of loan.
In addition, you need to have a large amount of equity in your existing home in order to qualify for a bridge loan. It is impressive to be able to borrow as much as 80 percent of your home’s value. However, this only works in your favor if your home has appreciated significantly in value from the time that you bought it or if you have paid down a relatively large amount of the principal.
Unless you have a low debt-to-income ratio, it is often difficult to gain approval for a bridge loan. Your lender will review this ratio for you, which is the amount of capital that you must spend each month, considering your current mortgage and other debts, in comparison to your monthly income.
Your lender needs to see that the amount of debt that you are responsible for is not larger than the amount that you can afford. This is especially important due to the cost of having two mortgages.
Bridge loans usually are issued only to applicants with good to excellent credit histories and credit scores. Also, if you do gain approval for one of these short-term loans, the higher your credit score is, the better your interest rate will be. With an excellent credit rating, you will most likely be granted a low interest rate on your loan.
Is a Bridge Loan the Best Option for You?
The question of whether a bridge loan is the ideal financial vehicle for you is dependent on several different important factors. It depends on your financial circumstances, your living situation, the current state of the economy and perhaps other matters.
It may be helpful to consult a trusted financial advisor to gain expert advice concerning loans. Then work with a top-rated, respected lending agent to secure a helpful bridge loan if this is the best funding option for you today.