What is a Bridge Loan?
Bridge loans are becoming more popular among homeowners looking to purchase another home in Palo Alto or any other Silicon Valley community prior to the sale of their original house.
Although equity loans can also be used to finance the down payment on the new house, bridge loans offer distinct benefits for certain buyers.
What is a Bridge Loan?
A bridge loan is temporary financing, normally ranging from 2 weeks to 3 years. This loan ‘bridges the gap’ between the sale of an existing home and the purchase of a new house. These are used during the time when the owner’s first home has not yet sold and is secured against the original property. The funds are used as the down payment on the new house with the plan to pay back the bridge loan and any accrued interest when the original house sells.
How do Bridge Loans Work?
Unlike securing a normal home loan, those institutions offering bridge loans may not have specific debt-to-income ratios or FICO (credit) score minimums. Rather, these loans are more by a ‘does this make sense?’ underwriting philosophy.
Some lenders exclude bridge loans payment when qualifying home owners for a conforming mortgage. This means that the bank will take into account the current mortgage payment plus the new mortgage payment but NOT the bridge loan payment. This allows more buyers to qualify for their new mortgage by omitting the temporary bridge loan.
The reasoning behind this two-payment qualification is threefold:
- Most purchasers do have an existing first mortgage on a current home.
- Odds are the buyer will close the sale on the new home before the sale of their existing home.
- For a short time, the buyer will own two houses and will have to fulfil two mortgages.
Benefits of Bridge Loans
As with anything, there are both pros and cons. The benefits of securing a bridge loan when you decide to ‘move up’ include:
- The ability to immediately put your current home on the market without restrictions. Many lenders will not extend an equity line if the home is on the market.
- Some bridge loans waive payments for a few months.
- If the buyer has made a contingent offer and is presented with a Notice to Perform, the buyer is able to remove the contingency and move forward with the purchase.
Drawbacks of Bridge Loans
Bridge loans tend to have higher interest rates than equity loans. Buyers will also have to be qualified by the lender to own two homes-their current house and their newly purchased house-and there are those who will not be able to meet this prerequisite. Also, for many people, making two mortgage payments plus accruing interest on a bridge loan can result in undue financial stress.
What Fees are Associated with Bridge Loans?
As always, rates vary depending upon the lender but the below offers an example of average fees that are incurred with a typical bridge loan. Though interest rates vary, let’s assume a rate of 8.5% with no payments due for four months. Interest will accrue from the outset and is due when the loan is paid in full, normally upon the sale of house #1. For those who already have a mortgage, these fees should look familiar.
Typical Bridge Loan Fees:
- Administration fee: $750
- Appraisal fee: $375
- Escrow fee: $350
- Title policy fee: $350
- Notary fee: $40
- Recording fees: $65
- Wire/courier fee: $75
There will also be a loan origination fee tied to the amount of the loan itself, with one point equaling one percent of the loan amount. An example of average fees is below:
- $25,000 to $100,000 = .50 points
- $100,000 to $150,000 = .75 points
- $150,000 to $250,000 = 1.0 points
Although the popularity of bridge loans is on the rise as homeowners trade up, there are definite pros and cons to securing this source of financing. It is recommended that each person consult with their financial advisor and mortgage lender to utilize the best options based on their unique financial situation.