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What is a Bridge Loan?
Bridge loan is a short term financing loan option that helps the borrowers to purchase a new property even before selling their currently owned property. These are considered as the short term real estate transactions where a quick funding is needed. They are also called as Interim financing, Gap financing or Swing loans. This gives the borrower the flexibility for the borrower to buy a new home while owning a current home and the mortgage interest rates are usually higher when compared to the traditional mortgage interest. The equity on the current home owned are considered as the collateral for the new loan. It usually has a loan term of less than 12 months, most bridge loans have term of around 2-3 months. Bridge loan acts as a bridge that bridges the gap between the current home that is being sold and new home that is yet to be purchased.
Bridge Loan Eligibility
Financial Strength
Lenders expect the borrowers to demonstrate that they have a strong financial source to be able to make the monthly mortgage payments. The bridge loan lender usually allow a loan to value ratio of 70-75% for residential properties. The borrower will be asked to provide their financial documents such as W2s, pay stubs, bank statements etc to make sure the borrower has the sufficient equity necessary to make the monthly payments.
Equity and Affordability
The lender is usually concerned with the equity of the property that is used as a collateral for the loan of the new property that will be purchased by the borrower. Once the lender is assured that the current property has enough equity, it gives them the security to provide loan for the new property being purchased and this also makes the loan sanctioning process faster.
Costs of Bridge Loan
The closing costs of Bridge Loan usually range from 1-5% of the total loan amount and include a number of fees and some of the fees are listed below. These costs vary by location, lender and other factors.
Appraisal fee
Escrow fee
Title Fee
Notary Fee
Loan Origination Fee
Home Inspection Fee
Underwriting Fee
Credit report Fee
Factors influencing the Bridge Loan rates
The interest rates on the bridge loan is influenced by a number of factors that are listed below.
Loan amount - The loan amount requested may vary from $20,000 to few million dollars.
Loan to value ratio - Most lenders expect the Loan to Value ratio to be at least 70- 75% to sanction the loan faster.
Credit score and credit history - If the borrower has a good credit history, then the lender might feel secured and assured that the monthly mortgage payments will be paid on time which might allow the lender to provide the borrower a loan with better interest rate and better loan terms.
Financial strength - If the lender feels the borrower has a good financial strength, then the lender might be comfortable to provide with better terms.
Property location, age and condition - The terms and interest rate of the loan may also be influenced by the location of the property, how old is the property and how well the property is maintained.
Example of Bridge Loan Process
Person A
Bridge loan amount - $300,000
Current home worth - $400,000
Current home loan amount - $200,000
Closing cost = $5000
Amount available for new loan = 300,000 - (200,000 + 5000)
= 300,000 - 205,000
= $95,000
Let's consider, person A plans to get a bridge loan of $300,000, in which $200,000 will go towards the current mortgage loan amount and $5000 towards the closing costs, then the amount available for the new mortgage loan is $95,000.
Pros of Bridge Loans
The borrowers have enough time to sell their current home and flexibility in finding the new home that they love as they have enough funds.
It avoids the hassle of moving to a temporary housing and they don't have to move twice to sell their currently owned home and buy their new home.
It gives the advantage of putting offers without contingency which is more appealing to the sellers.
In most cases, it allows the borrower to pay interest only payments until their currently owned home is sold.
It increases the affordability of the borrower to put down a large down payment or afford a bigger home which is not possible otherwise.
It makes the financing process faster as the bridge loan processes faster than the traditional mortgage process.
Bridge loan lenders are primarily focused on the value and equity of the property. The borrower who doesn't have a strong credit may not be eligible for the traditional loan as the traditional mortgage lenders are focused on the creditworthiness of the borrower, in which case Bridge loans comes to the rescue.
Cons of Bridge Loans
The Bridge loans usually have high interest rates and closing costs when compared to the traditional mortgage loans.
The borrower has a high risk of foreclosure of their current home as the currently owned home serves as the collateral.
If you are not able to sell your currently owned home for some reason, you may end up with two mortgages which might not be easy to manage.
Most lenders may require the borrowers to have at least 20% equity in their current home to be eligible for the Bridge loan.
The origination fees for the bridge loan may be higher than the traditional loan origination fee.
Alternatives to Bridge Loan
Home Equity Line Of Credit (HELOC) - This gives a line of credit based on the percentage of equity present on your current home which acts as a collateral. If approved by the lender, the borrower may borrow as much as money needed for the down payment of the new home if eligible. Then, the credit line is paid off when the current home is sold.
Home Equity Loan - Home equity loan is the type of loan obtained from the equity of the current home. If approved and the lender feels you are eligible, the lump amount obtained may be used as a down payment and the repayment of the loan must be started right away. The terms of the repayment of the loan are usually longer. The current home acts as a collateral.
Personal Loan - The borrower may also apply for a personal loan if they have a good credit history, debt to income ratio and other requirements required by the lender, they may get approved for a better interest rate than the Bridge loan.