What Is a Bridge Loan?
In today's competitive real estate market, a rare loan product may offer a viable solution for buyers wanting to purchase a new property before the sale of an old property. A “bridge loan” is a short-term loan taken out by a borrower for the purpose of temporarily financing the purchase of a new property. The loan is secured by some type of collateral, most often the property being sold or the real estate being financed by the loan.
How Bridge Loans Work
Offered by a select few banks and lenders, a bridge loan is typically good for at least six months but can often be extended up to a full year. Bridge loans can be structured in different ways depending on the borrower's need. The interest rate is often 2% or more above the average fixed-rate product, but it can vary widely along with terms and fees. A borrower may be able to secure better rates and terms by getting both the bridge loan and the long-term mortgage from the same lender.
Like interest rates and fees, repaying the loan can be achieved in a number of ways. Repayment of the loan could be structured as fixed monthly payments. Another option requires a one-time repayment at the end of the loan term or when the property sells, often with interest accruing during this time. Or, the loan could be structured with interest-only payments each month and a balloon payment at the end of the term or when the property sells. Payments on bridge loans usually aren't due until a few months after the close of the loan.
The underwriting guidelines for bridge loans frequently offer more flexibility than traditional financing.
Minimum credit scores and debt-to-income ratios may not be required. Often the main focus is on whether the loan makes sense and the borrower's ability to repay it.
Bridge loan financing is used in both residential and commercial real estate purchases.
Residential Bridge Loans
Without a large financial cushion, many borrowers don't have enough money to make a down payment on a new home before the sale of their old home. A bridge loan can be used to span the time between the purchase of the new property and the sale of the old property.
There are two common ways of setting up the loan. One option is for the loan to be large enough to pay off the mortgage on the old home and also be used for a down payment on the new home. Another option is to use the loan only for a down payment on the new home. Often, the collateral for the loan will be the home that is up for sale. Regardless of the option chosen — when the home sells, most borrowers use the proceeds to pay off the bridge loan.
There are a number of reasons why a bridge loan may be useful:
- Alleviates the "sell before you buy" dilemma
- Removes contingencies from the equation
- Provides increased leverage in a competitive housing market
Alleviates the "buy before you sell" dilemma
The stress of coordinating two transactions — the purchase of a new home after the sale of an old property — can be eliminated with a bridge loan. Instead, the buyer can focus on purchasing the property they want without the restrictions of having to sell their old property first. A bridge loan can give a borrower time to move into a new home, get settled, and then focus on selling the old one. When moving to a new community, this type of loan can alleviate the need for a buyer to temporarily rent a property while waiting for the old home to sell.
Removes contingencies from the equation
Another advantage of a bridge loan is that it allows the buyer to avoid a contingent offer — one that relies on the sale of another property. This can put the buyer at a disadvantage because many sellers won't accept a contingent offer of this type, especially in a seller's market. Removing this contingency through a bridge loan can make the buyer's offer more attractive
Increased leverage in a competitive housing market
In a competitive housing market, a bridge loan can allow the buyer to move swiftly with an offer. If the seller is prioritizing a quick sale, a borrower that can move forward immediately, without having to wait for their old property to sell, will often have leverage over other buyers.
Commercial Bridge Loans
A commercial bridge loan can be used in a similar way as a residential one — a business owner uses the loan to purchase a new property before selling another. However, commercial bridge loans can be used in other ways, too. It may be a good option when a company is trying to quickly purchase a property that could be lost in the time it takes to secure long-term financing. Or, a company may use a bridge loan until they can qualify for a traditional commercial mortgage, such as a newly purchased property with low occupancy rates or requiring major renovation. In addition, a bridge loan can be a short-term solution to cash flow issues when a business is waiting for long-term financing to come through.
Weighing the Rewards vs. Risks of a Bridge Loan
There are both benefits and risks associated with a bridge loan. The main risk is that the borrower's old property will not sell within the term of the bridge loan. A binding contract of sale on the old property can minimize this risk. In addition, borrowers can make an informed decision by researching the housing market in their area to determine an average of how long homes have been listed before being sold. Based on the findings, the borrower may want to negotiate terms that allow for a 6-month extension on the bridge loan.
Borrowers may also benefit from working with a single lender that provides both the bridge loan and the traditional long-term mortgage.
They may obtain better terms than if they used two different lenders. The borrower will want to carefully review all the terms of the loan and also watch out for prepayment penalties.
Alternatives to Bridge Loans
There are a number of alternatives to a bridge loan. Two that don't require the sale of investments for a down payment include Home Equity Lines of Credit and Pledged Asset Mortgages.
Home Equity Line of Credit (HELOC)
If a borrower has significant equity in the old property, a HELOC could be an option. Based on the borrower's maximum draw amount, they may be able to use the available money from their HELOC for the down payment on the new home. However, this is not an option if the old property is listed for sale. In most cases, the borrower will need an existing HELOC or will want to apply for one before putting their house on the market. Few lenders will give borrowers a line of credit once the property is on the market.
Financing a Down Payment With Pledged Assets
A less common down payment option is a pledged asset mortgage. It's an option when a borrower wants to purchase a property but doesn't want to make the down payment. Instead of a down payment, the borrower pledges assets such as stocks, bonds, CD's, savings, or mutual funds to use as collateral on the loan. Because the borrower isn't making a down payment, they will have to pay interest on the full price of the property.
Borrowers should compare a number of loan products and scenarios before making their decision to select a bridge loan. Like any loan, they come with rewards and risks. Exposure can be reduced when the borrowers are confident that their property will sell and have a plan in case it doesn't. In the right situation — when a borrower doesn't want to wait for the sale of another property, would like to avoid contingencies, or seeks to gain a competitive edge in a seller's market — a bridge loan can be a viable option for many borrowers.
For more information on Axos Bank and Wholesale and Correspondent Portfolio Lending, where mortgage brokers can find bridge loans and other portfolio niche products and services, please call 888-585-4869 or email [email protected] today.
To speak with a representative in the Commercial Bridge Lending division of Axos Bank, which specializes in providing bridge loans to owners, investors, and developers in need of funding, call 877-247-7994.
What is a Bridge Loan?
This blog post was published by Axos Bank on November 20, 2018 and last updated on December 11, 2018