What is a Bridge Loan?
Are you thinking of buying a new home? A bridge loan could play a role in making that happen. So, what is a bridge loan? Let’s take a look.
A bridge loan is a financing option that provides a borrower with funding until they can either obtain permanent funding or pay off the debt. Bridge loans are sometimes called swing loans. What is a bridge loan used for? Bridge loans are commonly used to finance the purchase of a new home while waiting for a current home to be sold. Here's a look at what you need to know if you're seeking a short-term financing option to help you purchase your next home.
Key Aspects of a Bridge Loan
What is a bridge loan in real estate? A bridge loan is a short-term financing option that typically has a term lasting one to three years. As shared above, the most common reason why people obtain bridge loans is to bridge the gap between buying a new home and selling an existing one. Having temporary funds to cover expenses during a transition period can help to ease the burden of holding two mortgages at once.
Bridge loans are typically secured by using a current home's equity or other asset. While there are many things that are similar between bridge loans and traditional loans, bridge loans generally have higher interest rates. However, the flexible repayment options can be attractive to borrowers.
Benefits of a Bridge Loan
The big perk of the bridge loan is that it enables a homeowner to purchase a new home before they have a chance to sell the one they currently own. This can be important in hot markets where buyers need to be prepared to make fast offers if they don't want to risk missing out on the homes they like. Additionally, a bridge loan offers fast access to funds that can help a buyer avoid closing delays with a new property.
For buyers, a bridge loan can also make their home offers more attractive. Buyers who don't intend to use bridge loans to cover financing gaps often have to make contingent offers on homes. This means that they have to get the seller to agree to make a sales contract dependent upon the buyer's ability to sell their current home. Ultimately, a bridge loan can be an attractive option for a homeowner who doesn't want to have to rent in between selling their current home and finding their new one.
How Does a Bridge Loan Work?
Like most financial products, a bridge loan's terms, conditions, and fees can vary greatly based on the borrower and lender. Everything from fees to repayment structure can vary. The best way to get an idea of how a bridge loan could work in your favor is to talk with a lender. However, the classic setup of a bridge loan is for the borrower to use the bridge loan as a second mortgage that enables them to put a down payment down for a new home. Once they sell their current home, the borrower can then transition to a traditional mortgage.
Examples of When to Use a Bridge Loan
What is a bridge loan and how does it work? Let's take a look at some specific situations where you might use a bridge loan:
- Scenario 1: You're ready to move into a bigger home. However, you can't afford a down payment because all of your money is tied up in the home you currently own. A bridge loan could potentially provide you with a way to put down a down payment on your new home now.
- Scenario 2: You need to find a way to get financing for a home quickly because you are transferring to a new area for a job opportunity. A bridge loan allows you to make offers on homes in your new area while you work on listing your current home with an agent.
- Scenario 3: After having multiple home offers rejected because you've made contingent offers while waiting for your current home to be sold, you're ready to start making more competitive offers.
Bridge Loan Mortgage Requirements
If you've applied for a mortgage in the past, you'll be happy to know that bridge loan requirements aren't that much different than the requirements for a Conventional mortgage. Generally, lenders like to see a credit score of 740 before they will approve a bridge loan. They also like to see a debt-to-income (DTI) ratio below 50%. Your DTI refers to the monthly income you take in versus what you pay out in bills. Lenders also look at something called loan-to-value ratio (LTV) when approving bridge loans. LTV refers to the size of a mortgage in relation to a property's appraised value. Most lenders allow applicants to borrow up to 80% of their LTV.
Bridge Loan Alternatives
What is a bridge loan mortgage alternative? Borrowers have three other mainstream financing choices beyond the bridge loan. Here's a look.
Home Equity Loans
A popular alternative to the bridge loan, the home equity loan lets you borrow money based on how much equity you can tap into from your current home. Your home equity is the difference between the amount you owe on your mortgage and your home's current market value. Home equity essentially refers to the portion of your home that you actually own.
While home equity loans are often more affordable compared to bridge loans, it's important to keep in mind that you'll be carrying two mortgages if your home doesn't sell quickly after you close on your new home. This is why home equity loans are more popular among people who plan to keep their first home after purchasing a new home.
HELOC
A home equity line of credit (HELOC) can be used to finance the purchase of a new home. A HELOC is often referred to as a second mortgage. In certain situations, a HELOC's lower interest rate can provide an ideal way for a buyer to put down a larger down payment on a new home. With a HELOC, borrowers withdraw money as needed during a window of time called a draw period. While the balance must be paid in full after the draw period closes, borrowers only pay interest on the amount they actually borrowed instead of the potential full loan amount.
80-10-10 Loan
While not as popular as a bridge loan, home equity loan, or HELOC, the 80-10-10 loan can provide a savvy loophole for avoiding the private mortgage insurance (PMI) that usually kicks in when borrowers don't put down 20% at closing. Also known as a piggyback loan, the 80-10-10 mortgage loan lets you borrow 90% of your home's value. While the first mortgage covers 80% of the new home's price, the second one covering the remaining 10% acts as a down payment.
While there are several ways to work out this type of loan, a classic 80-10-10 loan consists of a first mortgage that is a Conventional fixed-rate or adjustable-rate mortgage. The second mortgage is often a fixed-rate home equity loan or home equity line of credit (HELOC) with a variable interest rate. Gaining an understanding of HELOC vs home equity loan in terms of interest rates and repayment terms is important for determining which option aligns better with your financial goals.
