Bridge Loans: Everything You Need to Know
- Bridge Loans: Everything You Need to Know
- What is a Bridge Loan?
- How Does a Bridge Loan Work?
- When to Use a Bridge Loan
- How to Repay a Bridge Loan?
- Types of Bridge Loans
- Closed Bridging Loan
- Open Bridging Loan
- First Charge Bridging Loan
- Second Charge Bridging Loan
- Cash-out bridge loans
- Typical Bridge Loan Costs
- Bridge Loan Pros
- Bridge Loan Cons
If you are a buyer of real estate, you have probably been considering your mortgage options. In addition to fixed-rate and adjustable-rate mortgages, there are also bridge loans. A bridge loan solves the financing problem that arises when a home buyer purchases a new home before their current one sells. Rather than offer bridge loans, we understand the importance of educating you on home loan topics that are important to you. Here are some important things to know about bridge loans:
Bridge loans are designed to bridge the gap between demand for cash and its availability during short-term cash flow constraints. The short-term loan is commonly used by businesses while waiting for long-term financing, but consumers typically only use them in real estate transactions.
A two-step transaction involves purchasing a new building and selling the old one at the same time. In the case of two separate transactions that need bridging, you should consider looking for a bridge loan. The best option for you may be a bridge loan if you are unable to obtain traditional bank financing or if you need to move quickly to close a deal.
What is a Bridge Loan?
A bridge loan is intended to bridge the gap between cash demand and cash availability for immediate cash flow needs. Consumers typically use short-term loans only when buying a house. These loans are commonly used by businesses while they await long-term financing.
Specifically, bridge loans are used to avoid cash crunches and “bridge the gap” between buying and selling a home at the same time.
How Does a Bridge Loan Work?
In terms of bridge loans, there are a couple of options. In order to meet the borrower’s needs, lenders package temporary loans in two major ways:
- The difference between your current loan balance and the value of your home is borrowed in this case. While you keep your first mortgage until you eventually can repay it all when you sell your home, you apply the funds from this second mortgage towards your down payment for your second home.
- Taking out a single large mortgage for up to 80% of the value of your house allows you to roll both mortgages into one. Your first mortgage is paid off and your second mortgage is applied to a down payment on your next home.
Bridge loans are most often used by homebuyers to allow them to make a “contingency-free offer” on a new house, which means they can buy it without selling their existing home. The number of bidders on a house for sale can be an important consideration in a “seller’s market.” Sellers are more likely to accept an offer without a contingency because it means your house is not contingent on selling.
A piggyback loan allows you to avoid private mortgage insurance (PMI) by making a 20% down payment. In addition to being known as a “piggyback loan,” this type of loan requires mortgage insurance if you haven’t put down at least 20%, which increases your monthly payment. This is why some homeowners prefer a bridge loan over a conventional loan.
When to Use a Bridge Loan
A bridge loan might come in handy if you find yourself in one of these sticky situations.
- Contingency offers won’t be accepted by sellers in your area.
- The proceeds from the sale of your current house are not enough to pay for a down payment.
- While you are confident your house will sell, you prefer to find a new home before putting it on the market.
- The closing of your current house usually takes place after the closing of your new home.
Since the financial crisis a decade ago, First Savings Mortgage has already made more bridge loans than ever before. Despite their renewed popularity, their usefulness to people who want to win contracts in competitive markets cannot be overstated.
How to Repay a Bridge Loan?
Until you begin making repayments on the loan, it typically lasts about a year. You can repay your bridge loan with the money from the sale of your home, which is beneficial. The loan usually has a final due date for when it must be completely repaid. Making sure you are clear on the steps going forward requires working out repayment terms with your lender.
Typically, bridge loans must be repaid within 12 months or less. Most people repay their bridge loan with money from the sale of their current home, but there are other options. Bridge loans are generally structured in one of several ways, with a balloon payment at the end of the loan when the full amount is due.
If you have been approved for a bridge loan, you may be able to wait a few months before you have to start making payments.
Types of Bridge Loans
Open bridge loans, closed bridge loans, first charge bridge loans, and second charge bridge loans are all types of bridge loans.
Closed Bridging Loan
Bridging loans that are closed usually have a predetermined time frame that has been agreed upon by both parties. It gives lenders a greater degree of certainty about the repayment of the loan, so it is more likely to be accepted by lenders. Bridging loans with guaranteed repayments have lower interest rates.
Open Bridging Loan
There is no fixed payoff date for open bridge loans, and the repayment method is not determined at the initial inquiry. A majority of bridging companies deduct the interest from the loan advance to ensure the security of their funds. When borrowers are uncertain about when they will be able to obtain finance, an open bridge loan is preferred. This type of bridge loan carries a higher interest rate since lenders are uncertain about repayment.
First Charge Bridging Loan
The lender is given the first charge over a property when granting the first charge bridging loan. As soon as the borrower defaults on the bridge loan, the first charge lender receives the money first before other lenders. Despite low underwriting risk, the loan attracts lower interest rates than second charge bridging loans.
Second Charge Bridging Loan
The lender takes a second charge for a second charge bridging loan after the first charge lender. In general, these loans last for a short period, typically less than a year. Their default risk makes them more attractive to lenders, thus attracting a higher interest rate. A second charge loan lender will only recover payment from the client after all obligations owed to the first charge bridging loan lender have been met. As with a first charge loan, the bridging lender has the same right for repossession as a second charge lender.
Cash-out bridge loans
Borrowers who have a loan with an institutional lender with a low loan-to-value (LTV) rate and want to cash it out may benefit from cash-out bridge loans. Montegra can boost the loan principle to 65 percent of the current property value, allowing the borrower to put the extra money from the new bridge loan toward other investments. Montegra can also fund loans secured by properties that have already been paid off, allowing borrowers to borrow up to 65 percent of the value of the property and use the money to buy more properties or make modifications to existing ones. Montegra is committed to working with our borrowers to fund the loan that best suits their investment needs as a private capital bridge lender.
Typical Bridge Loan Costs
Be prepared to pay a higher interest rate on a bridge loan than on a conventional mortgage. Starting at the prime rate – 3.25 percent currently – and increasing based on creditworthiness, interest rates are calculated.
Your monthly payments for a conventional loan of $250,000 with a 20 percent down payment would be approximately $1,150 at the current prime rate. If you took out a bridge loan at 2 percent interest, then that same monthly payment would be $1380.
The closing costs, which range from 2 to 5 percent of the loan amount, must also be taken into account. Closing costs can include mortgage-related and property-related fees, whose costs vary based on location and lender:
- Application fee
- Appraisal fee
- Credit report fee
- Escrow fee
- Home inspection
- Origination fee
- Underwriting fee
- Title insurance and search
Bridge Loan Pros
You may find that obtaining a bridge loan is the right choice for you for a number of reasons, including:
- As a result, you will not have to rent a place if you decide to sell your old home before purchasing a new one
- A new home can be purchased by placing a current home on the market without notable restrictions
- A system that allows you to buy a new house without using your old home’s profits as a down payment
- There is a possibility of deferring or paying only interest until you can sell your old home, which gives you some flexibility
Bridge Loan Cons
The use of bridge loans can be beneficial in a variety of situations. However, there are some negatives to this type of loan that you should consider before applying. These cons include:
- The duration of bridge loans is extremely short and the lender must take on a great deal of work, which is why rates are often high, typically between 8.5 and 10.5 percent of the total loan amount.
- Depending on the terms of the loan, closing costs and fees may be high, which may increase your costs.
- Depending on your lender, the interest rate on the loan could increase over time since it is determined by a variable prime rate
- There is a possibility that your house won’t be able to be sold during the six- to twelve-month loan term, which would put you in a difficult situation
- Home equity loans are generally considered to be much more expensive than conventional home equity loans.