Bridge loans are useful for those who need access to cash for home renovations, improvements, or other costs related to home transactions. Property investors, in particular, may find them helpful as they seek out forms of financing that allow them to purchase, flip, and sell homes in a short period of time.
Below are some important specifics of a bridge loan, including what they are and the process for approval.
What is a bridge loan?
A bridge loan is a short-term financing option that provides a borrower access to cash for up to 12 months. Interest rates on bridge loans are higher than standard loans, often in the range of 10%—which can make them far more costly for borrowers.
However, the process for seeking approval for a bridge loan is faster and can give you access to funds relatively quickly. As a general rule, qualifying for a bridge loan shouldn’t be a problem if you already qualify for the home you intend to purchase.
The bridge loan process
Most often, buyers use a bridge loan when they identify a property they want to purchase but have yet to sell their current home. Simultaneous transactions are typically complicated to pull off, and a bridge loan can secure the funds necessary for a down payment prior to the sale of your current home.
Ultimately, you're leveraging the value of your current home to help you move forward in buying your new property. To acquire a bridge loan, you must first reach out to your current lender to secure the loan. Bridge loans are short, typically ranging from six to 12-months in length, covering the time frame between purchase and sale. If you think you currently won't or cannot sell in that timeframe, you should consider other options or work with a trusted real estate professional to better position the home.
It's worth noting that bridge loans are non-traditional loans: not every lender offers them. If yours doesn't, shop around to secure the best rates possible. Once your home sells, you'll apply those proceeds to pay off the bridge loan. Upon completion, you're left with only your current mortgage.
It's important to note that while many homes will sell within the bridge loan's maximum 12-month time frame, some may not. Should that happen, you could end up responsible for three very costly loans—your current home's mortgage, your new home's mortgage, as well as the bridge loan. This is a definite worst-case scenario and a major reason why bridge loans carry more risk than conventional loans.
When to consider acquiring a bridge loan
Bridge loans are most advantageous when wanting to service a new home without waiting on your current one to sell. In a volatile market, there's a peace of mind that comes with that type of flexibility. But there are a few other scenarios where a bridge loan can prove beneficial in helping you meet your real estate goals, including:
Overcoming a seller that will not accept a contingent offer
Avoid contingent scenarios altogether, strengthening your offer on a new home
Inadequate funds for a down payment on a new home
If the closing of your new home occurs prior to your current home closing
As an investor, bridge loans allow you to quickly acquire, renovate, and flip a property
When considering a bridge loan, it's helpful to understand current market conditions. You can utilize a bridge loan at any time, but doing so within a favorable seller's market provides you the best chance for success. If you're uncertain, don't hesitate to discuss market specifics with your real estate professional to ensure favorable timing for your bridge loan.
Bridge loan example and fees
A bridge loan can serve as either your primary mortgage on your current home or as a second mortgage. Consider:
First mortgage bridge loan: Your lender approves a loan to pay off the balance of your current mortgage, as well as enough funds to use towards a down payment on a new property. The existing mortgage is now paid off and serves as the primary loan. You'll pay off the loan upon the sale of your current home.
Second mortgage bridge loan: Your lender approves a loan for the amount of funds necessary to afford a down payment on a new property. As this loan is secured based on your current home, it's considered a second mortgage.
Bridge loans are structured to allow you borrowing power of up to 80% of the value of your current home. While lenders' terms will vary, in specific scenarios, you may be able to make interest-only payments or defer payments until the current home sells.
Example of a bridge loan:
Assume you have a Roaring Fork Valley home worth $1.5 million. You owe $250,000. You're looking to downsize into a new home for $1 million and want to ensure a 20% down payment of $200,000.
In the first mortgage scenario, you borrow $465,000, paying off your current home mortgage, leaving $200,000 for a down payment and $15,000 for closing costs (typically around 3%).
In the second mortgage scenario, you borrow $210,000, enough to cover the down payment and approximately $6,000 in closing costs.
Additional fees may apply and will vary between lenders. In addition to the approximately 10% interest rate and 3% in closing costs, other fees may include origination, administration, and appraisal charges, as well as escrow and title costs.
Bridge loan requirements
Qualifying for a bridge loan is a reasonably straightforward process, though it does require meeting specific parameters outside the typical loan process. The basic tenants for bridge loan approval include:
Your lender will also consider the housing market in making their assessment. It will prove challenging to acquire a bridge loan in markets unfavorable to sellers.
Bridge loan alternatives
As advantageous as they are to secure much-needed funds, bridge loans are not always the best option for real estate transactions. In addition to the high interest rate, it's a risky proposition should your current home languish unsold. Some alternatives include:
Home Equity Line of Credit (HELOC): allows borrowers to secure a loan against their current home's equity and on a revolving basis if necessary; repayment periods are longer (up to 20 years), and interest rates considerably lower
Home Equity Loan: similar to a HELOC, except for the loan being a lump payment versus on a revolving basis
80-10-10 Loan: also referred to as a piggyback loan, the 80-10-10 allows borrowers to secure a mortgage covering 80% of the purchase price, paired with a second loan for 10% of the down payment on the new home; this loan allows you to avoid private mortgage insurance (PMI)
Final thoughts: bridge loan pros and cons
While every situation is different, if you're looking to acquire new Colorado luxury real estate without the burden of having to sell your current home first, a bridge loan is a good option for navigating the purchase. But as with every transaction, you'll want to weigh the positives and negatives and ensure such a loan is right for your specific home buying needs.
Immediate access to cash allows flexibility during your new home search
Take your time in finding the perfect house for your needs
Eliminate the need for contingent offers, which also strengthens your position versus other buyers
Avoid the possibility of needing temporary housing or having to make multiple moves
Won't incur PMI on your new home purchase with access to a 20% down payment
Conversely, a bridge loan is risky due to higher interest rates and the potential for foreclosure should your current home not sell in a reasonable amount of time. If you find yourself in a sluggish or cooling market, it's worth your time to explore other options to secure the home you want.
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