What Exactly are Bridge Loans?
How Do Bridge Loans Work?
Bridge loans are popular in certain types of real estate markets. Whether bridge loans are a good option for you depends on several factors. The reason buyers take out a bridge loan is to buy another home before selling an existing residence. That may sound like an ideal solution, but a bridge loan is not without risk.
For example, when a home buyer is buying another home before selling an existing home, two common ways to find the down payment for the move-up home is through financing either a bridge loan or a home equity loan (or home equity line of credit).
I advise sellers to wait before buying a home and sell the existing home first, but many feel an urge to locate their move up home first.
If you are absolutely certain your existing home will sell, it will alleviate fears about what happens if it does not. You might want to talk with a trusted advisor before pursuing a bridge loan. The main advantage to a bridge loan is to avoid a contingent offer and make your move-up offer all that more attractive to a seller.
Generally, a home equity loan is less expensive, but bridge loans contain more benefits for some borrowers. In addition, many lenders will not lend on a home equity loan if the home is on the market. Smart borrowers will compare the benefits between the two loans to determine which is a better fit for their particular situation and plan ahead before making an offer to purchase another home.
A major benefit to a bridge loan is the fact it allows you to buy a new home without a contingency to sell.
In seller's markets, many sellers will not accept a contingent offer. If you have a home to sell, that could mean you might not be able to buy a home any other way than without a contingency.
What Are Bridge Loans?
Bridge loans are temporary loans that bridge the gap between the sales price of a new home and a home buyer's new mortgage, in the event the buyer's home has not yet sold.
The bridge loan is secured to the buyer's existing home. The funds from the bridge loan are then used as a down payment for the move-up home.
How Do Bridge Loans Work?
Many lenders do not have set guidelines for FICO minimums nor debt-to-income ratios. Funding is guided by a more "make sense" underwriting approach. The piece of the puzzle that requires guidelines is the long-term financing obtained on the new home.
Some lenders who make conforming loans exclude the bridge loan payment for qualifying purposes. This means the borrower is qualified to buy the move-up home by adding together the existing loan payment, if any, on the buyer's existing home to the new mortgage payment of the move-up home. The reasons many lenders qualify the buyer on two payments are because:
- Most buyers have an existing first mortgage on a present home.
- The buyer will likely close the move-up home purchase before selling an existing residence.
- For a short-term period, the buyer will own two homes.
If the new home mortgage is a conforming loan, lenders have more leeway to accept a higher debt-to-income ratio by running the mortgage loan through an automated underwriting program. If the new home mortgage is a jumbo loan, most lenders will restrict the home buyer to a 50% debt-to-income ratio.
Average Fees for Bridge Loans
Rates will vary among lenders, but following is an average estimate for a bridge loan in California. Interest rates fluctuate, but for this example, let's use 8.5%. This type of bridge loan will carry no payments for four months; however, interest will accrue and be due when the loan is paid upon sale of the property. Here are sample fees, submitted by an actual mortgage broker*:
- Administration fee: $850
- Appraisal fee: $475
- Escrow fee: $450
- Title policy fee: $450+
- Notary fee: $40
- Recording fee: $65
- Wire/courier/drawing fee: $75
In addition, there is a loan origination fee on bridge loans based on the amount of the loan. Each point is equal to 1% of the loan amount. Here are average fees, submitted by a mortgage broker*. Again, fees will vary.
- $25,000 to $100,000 = .50 points
- $100,000 to $150,000 = .75 points
- $150,000 to $250,000 = 1.0 points
Home Buying Benefits of Bridge Loans
- The buyer can immediately put her home on the market and buy without restrictions.
- Bridge loans may not require monthly payments for a few months.
- If the buyer has made a contingent offer to buy and the seller issues a Notice to Perform, the buyer can remove the contingency to sell and still move forward with the purchase.
Home Buying Drawbacks of Bridge Loans
- Bridge loans cost more than home equity loans.
- Buyers will be qualified by the lender to own two homes and many may not meet this stringent requirement.
- Making two mortgage payments, plus accruing interest on a bridge loan, could cause stress.
*Note: Thanks to Evelyne Jamet at Vitek Mortgage for providing the sample bridge loan fees.
DISCLOSURE: Vitek Mortgage is a preferred vendor for my employing brokerage and enjoys an affiliated relationship with Lyon Real Estate.
At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.