Bridge Loans Guide 2022CASAPLORERTrusted & Transparent
What You Should Know
- A bridge loan is a short-term loan that provides liquidity to the buyer to close on a new house before their house is sold.
- These loans usually have a term length of 12 months, and they have a high interest rate, so it might be beneficial to pay them off as soon as the buyer has the money for them.
- Even though it is better to avoid bridge loans, they can be very helpful during a seller’s markets because buyers might have to close quickly to not lose the deal.
What Is a Bridge Loan?
A bridge loan is a short-term loan that provides liquidity and financing during the transitionary period when the borrower’s existing home has not sold, and the new home is in closing. It essentially allows individuals to ‘bridge’ the gap between the two transactions of selling an existing home and using those funds to buy a new home.
In most cases, it is very difficult to time the selling of your current home and purchase of a new home, therefore, bridge loans help ensure that you can buy your new home without needing to have funds immediately available from the sale of your current home. Bridge loans are short-term that are paid back within 12 months. They have relatively higher interest rates as compared to mortgages and are secured by collateral on your existing home.
How Do Bridge Loans Work?
Bridge loans can be structured in various ways. The two main methods used by lenders are:
1. Second Mortgage: Pays down payment on the new home
This method works like a second mortgage. You borrow funds based on the equity you own in your existing home, which is then used to pay for the down payment on the new home. You can increase your loan-to-value (LTV) ratio up to 85% which would be calculated based on your first and second mortgages. This type of bridge loan works similarly to a home equity loan, where the existing home is used as collateral. In this case, you have to make sure that you can keep paying off your first mortgage, second mortgage, and potentially another mortgage if you close the deal on the property you want to buy.
For example, if your existing home is valued at $400,000 and has an outstanding balance of $250,000, this means that you have $150,000 in home equity. If you borrow up to 85% of the home value, which is $340,000 ($400,000 * 85%), you will get a total bridge loan of $90,000 ($340,000 - $250,000). If closing costs and fees for the bridge loan are around $15,000, you will have $75,000 available. This $75,000 can be used by you to cover the down payment for the new home, while your current home is in the process of being sold.
If you are struggling to understand how much cash you can receive using this method, you can use a HELOC calculator to estimate the amount of equity you can withdraw.
2. Lump-sum Loan: Existing mortgage payoff and down payment on the new home
In this method, you borrow funds based on the value of your existing home. These funds are then used to pay off the remaining mortgage balance with any additional funds to be used for the down payment on the new home. You can borrow up to 80% of the home value in this case.
For example, if your home is valued at $400,000 and has an outstanding balance of $250,000, you can borrow a lump sum of $320,000 ($400,000*80%). Out of the $320,000 that you can borrow, the outstanding balance to be paid is $250,000, leaving an additional $70,000 ($320,000 - $250,000) to be used for the down payment of your new home.
In both methods, it is assumed that the loan is being taken with your current home as collateral and that the home will sell fairly soon. Once the home is sold, the funds from the sale are used to pay off the bridge loan and accrued interest. In the event the home does not sell, the entire bridge loan will be due along with the new monthly mortgage payments. This can result in severe financial strain and may eventually result in you defaulting on one or both of the debt payments. Therefore, although bridge loans provide an elegant solution to the issue of lack of liquidity, it can also result in default and foreclosure.
Advantages and Disadvantages of Bridge Loans
Bridge loans, just as any other loan, have their advantages and disadvantages. It is important to weigh them before choosing to proceed with getting a bridge loan. It is also important to make sure that you can sustain the monthly payments that come with the loan in case you are not able to sell your house as quickly as you expect.
- No Need for Sale-Contingent Offers: When you are purchasing a home, there is a clause that allows you as a buyer to back out of a purchase deal if your current home does not sell. In a seller’s market where there are several buyers for a single home, a sale contingent offer can be looked down upon as the buyer has the option to leave the deal if their existing home does not sell. Sellers do not like this as they are not guaranteed that the deal will go through. Therefore, bridge loans allow the buyer to place an offer without the sale contingency offer, making their offer much more attractive.
- Fast Access to Cash: You get immediate access to cash liquidity which can then be used for the minimum down payment on your new home.
- Interest-Only or Deferred Payments: The payments required for the bridge loan may be interest-only or deferred until you sell your existing home. This can give you flexibility as the payments can be made once the term of the bridge loan is over, which should be after the existing home is sold.
- Quick Process Time: In general, bridge loans require less time to be processed as the underwriting and funding process is faster than traditional loans.
- High-Interest Rate: As these are short-term loans that can involve risks for the lender, they charge a higher interest rate on the loan. Some lenders also give a variable rate that is tied to a benchmark index, like the Prime rate, which is connected to the Fed funds rate.
- Appraisal Requirement: Apart from fees and other costs, you might also require an appraisal which adds to the cost of getting a bridge loan.
- Need at least 20% home equity: You are required to have at least 20% equity in your existing home or an LTV ratio of 80% if you are to be eligible for a bridge loan.
- Home as collateral: Since the home is the collateral, any default in payments can result in foreclosure.
- Debt Repayments: After a certain period of time, you could be paying a mortgage on your existing home and making repayments on the bridge loan. This can result in financial stress or default.
When Should I Use a Bridge Loan?
There are certain cases where the use of a bridge loan can be extremely helpful.
- Market Condition: If you are in a seller’s market and they do not accept sale contingent offers, you might have to get a bridge loan to close the deal.
- Down Payment: If you cannot make the minimum down payment on your new home while making debt payments on your existing home, then a bridge loan could help make up the difference.
- Timing: You have found the new home you want to buy but have not been able to receive the funds from the sale of your existing home. Rather than losing the buying opportunity, you can use a bridge loan to provide liquidity during the transitionary period.
- Preference: You would rather close on your new home before selling your existing home.
Bridge Loan Alternatives
If you feel bridge loans are not the right option for you because of the higher interest or the risk, there are other alternatives available:
- Home Equity Line of Credit (HELOC): A HELOC allows homeowners to borrow funds by using the equity they own in their home as collateral. Most lenders allow up to 80% of the home value to be borrowed. HELOC functions like a credit card where funds can be borrowed and paid back, giving a lot of flexibility to the borrower. HELOCs charge a lower interest rate than bridge loans, however, they cannot be used if the home is up for sale. Therefore, if a HELOC is being used for the purpose of providing liquidity then it should be used to buy the new home first and then sell the existing home. You can check your monthly HELOC payment using our HELOC payment calculator.
- Home Equity Loan: A home equity loan is similar to a HELOC where you borrow funds based on the equity you own in the home, however, instead of it being a line of credit, it is a lump-sum amount. Home equity loans are also cheaper than bridge loans as they have lower interest-rate charges.
- Piggyback Loan: Using a piggyback loan, which is also known as an 80-10-10 loan, you first take a mortgage on the new home for 80% of the home value, following which you take a second mortgage for 10%, and you pay the remaining 10% out of pocket. Once your existing home sells, you use those funds to pay off the second mortgage. This strategy allows you to put little upfront and avoid private mortgage insurance (PMI), as the overall down payment is more than 20%.
Applying for a Bridge Loan
Bridge Loan Eligibility Requirements
Bridge loans have similar requirements to a mortgage. The basic requirements are as follows.
|LTV Ratio < 80%||A loan-to-value (LTV) ratio of no more than 80%. You must have at least 20% equity in the home to qualify for a bridge loan.|
|Credit score > 620||The minimum credit score required by your mortgage lender and program, which in most cases should be greater than 620.|
|DTI Ratio < 43%||The maximum debt-to-income (DTI) ratio allowed by your mortgage lender and program, which in most cases should be less than 43%.|
Bridge Loan Costs
The interest rates offered on bridge loans are much higher than the interest rates for mortgage loans. Even though these loans are paid out in under 12 months, the interest payments may add up quite quickly if the loan has a large principal. The interest rate charged on a bridge loan usually varies from 8.5% to 10.5% although the rates may change as prime rates change. This means that when prime rates increase, the interest rate for bridge loans increases too. In addition to that, there are closing costs that a borrower has to pay at the time of loan origination. They usually account for up to 2% of the loan amount, and they include the following:
- Administration Charges
- Appraisal Costs
- Title Policy Fee
- Escrow Costs
- Wiring and Notary Fees
Residential Bridge Loan Lenders and Rates
Residential bridge loans are used much less often as mortgage loans or even home equity loans. They are also considered riskier than the other loans used in real estate transactions. Because of that, large institutional lenders tend to avoid offering bridge loans to save costs and minimize their risks. Since large lenders do not offer these services, it might be difficult to find lenders who would be willing to provide this type of loan. On the other hand, there are some small lenders, credit unions, and private lenders that would be happy to issue a bridge loan. The following list provides the names of lenders who issue bridge loans as well as the terms and conditions of their loans and the qualifications required.
This company focuses on providing banking, insurance, and investment services to individuals and businesses. Their large portfolio of services includes residential bridge loan issuance. They offer bridge loans with a combined LTV of up to 80% or a loan value of up to $350,000. They also allow the borrowers to make interest-only payments with a balloon payment at the maturity of the loan. To qualify for this loan, a borrower must have a minimum credit score of 640 and have their current home listed for sale.
- Liberty Financial
Liberty Financial provides money management services and loan opportunities for personal and business use. When it comes to bridge loans, Liberty Financial claims to have low interest rates and closing costs, and interest-only payments, which may be useful when getting a bridge loan. In addition to that, they are willing to finance a property with an LTV of up to 90% of the appraised value. On the other hand, they only have a 9-month term, which may not be enough for some individuals.
- Normandy Mortgage Banker
This lender provides financing for residential and commercial properties. They offer various loans that can be used to acquire properties and land as well as finance construction projects. They offer residential bridge loans for the principal amount from $75,000 to $5,000,000 and LTV of up to 80%. It is important to note that any bridge loan with a principal amount over $1,000,000 can only have an LTV of up to 75%. This company has a fast pre-qualification process that typically takes 3 to 5 business days. Lastly, they offer a 12-month term with interest-only payments.
- Midland States Bank
This bank operates mainly in Illinois and Missouri. They claim to have competitive interest rates and a quick and smooth loan origination process. They are focusing on the client experience, so their clients receive help from their experts and an easy online application process. They also offer multiple repayment options including fixed monthly payments, interest-only payments, or no payments until the borrower’s house is sold.
- Banner Bank
Another lender that offers residential bridge loans is Banner Bank. They issue a bridge loan for the LTV of up to 80% of the mortgaged property provided that it is listed for sale. It provides an interest-only loan for up to 12 months. They claim to have competitive rates, fast processing requests, clear and responsive answers, and exceptional customer service.
Commercial Bridge Loan Lenders
Bridge loans are much more popular when it comes to commercial real estate and investment properties. Generally, it might not be a problem for households to save up money for a down payment on a house, but when down payments surpass hundreds of thousands of dollars, it might be difficult to raise that much cash at once even for an investment company. This is why there is a larger demand for bridge loans in the investment sector.
Since there is a larger demand, there is also a larger supply of financial solutions that might not only be beneficial for businesses but also interesting in their nature. Different lenders create unique financial solutions that may help specific businesses when it is needed.
For example, the US Small Business Administration (SBA) created a pilot program that can be considered a bridge loan, but it provides liquidity for small businesses that are located in declared disaster areas. This program is called SBA Express Bridge, and it is designed to provide expedited financing of up to $250,000 to qualifying businesses for up to 7 years. To qualify, a small business must be located in a place of disaster at the time of disaster. The minimum acceptable credit score for this loan is 140 which must be issued by E-Tran.
Bridge Loan Regulations
Even though bridge loans are mainly used for real estate transactions, they are not regulated the same way other mortgage loans do. There are usually two regulation levels that apply to bridge loans: federal and state. When it comes to federal-level regulations, bridge loans are often exempted from most of the sections that regulate other primary and higher-cost mortgage loans. The reason for these exceptions may be due to a specific nature and goal of the bridge loan, which is to provide liquidity for a short period rather than providing traditional financing. Some states also have state-level provisions regarding bridge loans. They may differ depending on the state a lender is operating in.
For example, most real estate transactions are regulated by the Real Estate Settlement Procedures Act (RESPA). RESPA outlines the basic rules for loans originated including how the disclosure of transactions, fees, and any business affiliations related to the translation is done. This act covers most of the mortgages that are being secured or bought by the government and quasi-government agencies like Fannie Mae and Freddie Mac. This means that most conventional and conforming loans are being regulated by RESPA.
Bridge loans are not regulated by the RESPA, unlike conventional and conforming loans.
On the other hand, it is regulated by the Truth in Lending Act (TILA). This act provides an overview of the limitations and permissions of higher-priced loan types that are usually supplementary to a primary mortgage loan on a house. When it comes to bridge loans, this act regulates the following topics related to bridge loans:
- Section 1026.32(d) of TILA
This section states that loan terms including negative amortization, interest rate increases after default, and prepayment penalties are generally prohibited while balloon payments and due-on-demand clauses are restricted for high-cost mortgages. This section applies to bridge loans, and it means that lenders are not allowed to issue bridge loans that include negative amortization, increase interest rates due to borrowers’ default and charge prepayment penalties. It also states that balloon payments are permitted for this type of loan.
- Section 1026.35(b) of TILA
This section talks about the necessity of establishing an escrow account before originating a higher-priced mortgage loan including a high-cost mortgage loan. On the other hand, this section clearly states that bridge loans with a loan length of 12 months or less are exempt from this requirement. This means that a bridge loan can be issued before an escrow account is opened.
- Section 1026.35(c) of TILA
This section describes appraisal requirements for issuing higher-priced loans for a property. More specifically, it states that the loans must not be issued without obtaining a written appraisal of the property that is being mortgaged. In addition to that, the appraisal must be performed by a state-certified or licensed appraiser. Bridge loans are mentioned as an exception to this rule, so bridge loans are permitted to be issued without a written appraisal.
- Sections 1026.43(a), (g), (h) of TILA
These sections refer to the ability of a borrower to pay off the issued loan. A lender must reasonably and in good faith ensure that the borrower can repay the loan. These clauses do not apply to bridge loans that have a length of 12 months or less. This means that a lender may originate a bridge loan to a borrower who may not be able to repay the loan, which may lead to a default and possible foreclosure on the property.
Some states have provisions that apply to bridge loans. Most of the time, these provisions target the lenders rather than borrowers, which means that the borrowers are not required to comply with the state-specific regulations unless otherwise specified. If there are any provisions that a borrower must be aware of, they will be notified at the time of bridge loan inquiry. The states that have certain regulations applicable to bridge loans include the following:
New York state has a document related to bridge loans, which is called N.Y. Comp. Codes R. & Regs. Tit. 3 § 80.11 - Bridge loans. This document provides the state regulations imposed on bridge loans. More specifically, it outlines 6 distinct terms and conditions for issuing a bridge loan:
- The loan must be paid out upon the closing of the borrower’s sale of the property that has been used to secure the bridge loan.
- The borrower can repay the loan at any time without any prepayment penalty.
- The notification provisions outlined in section 80.5 of this document must apply to the loan throughout its lifetime.
- The disclosure provisions outlined in section 80.4 of this document must apply to the loan unless the loan contains a balloon payment. If the loan contains a balloon payment, an alternative disclosure must be provided.
- Regardless of the number of terms the loan is offered for, the fees and points may be taken only at the origination of the loan, and the borrower may not be charged more than 3 points at a time.
- The loan must have a fixed interest rate within each term of the loan.
Michigan has issued a Consumer Mortgage Protection Act of 2002 that describes prohibitions of certain lending practices, disclosure requirements of certain home loan information, prescribes certain duties and obligations to lenders in home loan transactions, and penalties for misconduct. One specific provision that this act states is that mortgage loans with a term length of under 5 years must not have a payment schedule that does not fully amortize the outstanding principal balance except bridge loans. This means that in Michigan, a borrower may end up still owing money at the time the bridge loan expires, so they would have to make a balloon payment at the expiry date.
Texas has its own laws on home equity. The bridge loans taken out in Texas must comply with the Texas Home Equity Provisions (A6). The A6 provisions apply to any cash-out home equity loan on a primary residence in Texas. Since it is regulated the same way as other ways to receive money using equity, such as HELOC or cash-out refinance, bridge loans are not an attractive option to use in Texas. The homeowners usually look for other options to secure a loan that has more beneficial terms, conditions, and qualification requirements.