Moving from one home to another is rarely a smooth process as it depends on a long chain of events that should perfectly align. But sometimes the element of luck cannot be evaded and homeowners are faced with a missing link. What happens when the current home has not sold yet and money intended for the purchase of a new home is not available? Homeowners grasp for a bridge loan to bypass the delay in financing.
Features of a bridge loan
So, what is a bridge loan? Aptly named, a bridge loan is designed to provide funding for a new property until the current one has sold. Normally, terms of bridge loans vary from lender to lender, but most of the characteristics are shared:
- These are short-term loans. The maximum repayment period for bridge loans is often between six months and a year, although it can be extended. The minimum repayment period is usually a month.
- They can be quickly approved. Terms and conditions of bridge loans are more flexible and long-lasting detailed evaluations necessary for standard mortgages are not needed. The most important elements of the assessment are the existing home value or equity and credit score of the borrower.
- Bridge loans take existing home as collateral. This is good news for those interested in downsizing, as they can rely on a higher loan; either due to higher current home value or higher equity. The bad news is, complications with the loan repayment can result in foreclosure.
- The interest payment is flexible. These loans provide borrowers an option to pay interest at the end of the repayment period instead of monthly.
- They are more expensive. This is simply because lenders can’t make much money on short-term loans and, thus, raise interest rates.
- Bridge loans provide a 75-80% loan to value, depending on the collateral property value. In other words, to approve bridge financing, lenders require 20-25% of equity.
Even though lenders compete for clients offering more flexible terms, extension options, or fees, borrowers should weigh the pros and cons and calculate bridge loans carefully. While undoubtedly beneficial, bridge loans do not come without any risks. Learning about them is one of the not-so-obvious moving tips to study before you decide to buy.
When do bridge loans come in handy?
Bridge loans are not intended only for purchasing residential property when you have to move on short notice; they can be helpful in a variety of situations. However, all these situations have one thing in common: the sale of the collateral property covers the loan. Bridge financing works well for landlords competing over investment properties, property purchases with short deadlines like auctions, or borrowers who wish to extricate from multiple mortgages before purchasing a property. But that is not all.
Purchasing a home in a sellers’ market implies competition among buyers and often the one with the ready funds wins the preferred home. Any conditions regarding payment presented to the seller are likely to be a deal-breaker. Sometimes, sellers don’t even consider contingent offers. All sellers, including the buyer who is about to sell their home, hope for a quick sale. Bridge loans ensure that the funds are ready once the opportunity for the purchase of the right home arises.
In the ideal case, closing on the current home sale is scheduled before the closing on the new home purchase. Bridge loans come in handy in less than ideal situations when these dates are reversed. They are especially helpful in case of short delays. Depending on the lender, lenders usually charge interest rates only on the duration of the loan. Moreover, lenders do not charge early repayment fees due to the features of these short-term loans.
Using a bridge loan
A borrower can utilize a bridge loan either as a second mortgage or as a means to pay off the current mortgage and put the remaining amount of the loan toward a down payment for the new home.
In the first case, a bridge loan depends on equity. In the latter case, the loan depends on the home value. The funds received through the loan will cover the mortgage and a part of the down payment, assuming the current home sells on time.
Potential risks coming with bridge loans and the importance of an exit strategy
Possibly, a homeowner may not even get approved for a bridge loan. If a homeowner doesn’t qualify to own two homes at once, a loan will not be closed.
Also, it may happen for a variety of reasons that the borrower’s buyer pulls out of the deal and the original home sale fails. Even though the potential risks of a loan can be mitigated, homeowners should wait for a while before calling local Best Cross Country Movers and schedule relocation to a new home. If home selling doesn’t close, borrowers would have to pay two mortgages, the loan, and moving expenses.
If the borrower’s finances prove insufficient to cover these expenses even by the extended repayment date, they should expect a foreclosure on the collateral (the current home). A bridge loan approval often insists on a solid credit score which is helpful, but even so, pressure on the finances may be too great and the risk should not be ignored.
While it is advisable to wait with the purchase until the existing home has sold, sometimes it is not possible. Having in mind the potential risks coming with any loan, a borrower should create a solid exit strategy. This is especially important for bridge loans, where the current home is at stake. An exit strategy is a plan that should ensure a timely repayment. Usually, it includes actions that will help or speed up the sale of the collateral home.
Bridge loans are designed for a very specific purpose and as such, they serve it well as long as everything goes according to plan. However, if the original home sale doesn’t close, implications of an unpaid bridge loan may be dire. Before securing such a loan, one should carefully weigh the benefits and downsides. Now more than ever, borrowers should play safe.