Understanding the Power of Bridging Loans. The dynamic world of real estate can move quickly. Opportunities may arise when you least expect them, and sometimes, the conventional mortgage process can’t keep pace. In such situations, bridging loans step in as a viable financial solution. Let’s delve into the details of these short-term loans to help you make well-informed decisions.
Deciphering the Power and Concept of Bridging Loans
To put it simply, your home equity is the disparity between the value of your property and your outstanding mortgage balance. You can calculate your equity bridging loan to find out more.
A bridging loan, often referred to as a swing loan or gap loan, is a short-term financing solution designed to bridge the financial gap between selling your current home and purchasing a new one. This loan type leverages the equity in your current property. Even if it’s listed for sale, it enables you to make a down payment on a new property.
Bridging loans can be a lifeline in times of need, providing a more flexible alternative to a cash-out refinance. Which restricts you from borrowing against your property’s equity if it’s listed for sale. Moreover, these loans can help streamline the process of buying and selling a property simultaneously.
Scenarios Where a Bridging Loan May Be Apt
Bridging loans can prove to be a financial boon in various circumstances, such as:
- Competitive Home Purchase: In a market where there are multiple bidders. Sellers are less likely to accept an offer contingent on the sale of your current property. However, if you require funds from your existing property to make the new home purchase affordable. A bridging loan can help you bridge the financial gap until your property stands sold.
- Purchasing a Fixer-Upper: If you plan to buy a property that requires substantial repairs. But if those repairs don’t meet conventional loan guidelines, a bridging loan can come to your rescue. It can provide additional funds needed to complete the renovations without having to dip into your savings.
- Fix-and-Flip Home Purchase: If you’re planning to renovate and quickly sell a property, a bridging loan can be a practical choice. If all goes according to plan, the loan can repaid once renovations are complete. Bridging loans can often be procured faster than traditional financing, allowing you to secure a property swiftly.
The Mechanics of a Bridging Loan
While a bridging loan functions similarly to a typical mortgage, there are a few notable differences:
Selection of Mortgage Type
You can opt for one large loan that covers your current mortgage balance and provides additional funds, or you can obtain a smaller loan against a segment of your home’s equity.
Here’s a breakdown of each option:
- First-Mortgage Bridging Loan: A lender provides you with a single loan that covers your current mortgage balance and the required down payment. Your existing mortgage pays off, and the bridging loan takes precedence until you sell your existing property and repay the loan.
- Second-Mortgage Bridging Loan: A lender offers you a loan for the down payment on your new home but leaves your current mortgage balance untouched. This loan stands secured by your existing property, making it a second mortgage.
Loan-to-Value Limit
Whether you opt for a first- or second-mortgage bridging loan, you won’t be able to utilise all of your home’s equity. Typically, you can borrow up to 75% of your home’s value. If you have less than 20% equity, a bridging loan may not be a feasible option.
Payment Structure
Payment terms can vary depending on the lender. You may offer interest-only monthly payments, no payments until the property stands sold, or traditional fixed monthly payments.
Closing Costs and Potential Prepayment Penalties
Closing costs for a bridging loan typically range between 1.5% and 3% of the loan amount. Additionally, the loan rates can be as high as 6.99% to 8%, depending on your loan amount and credit profile. Be wary of lenders demanding upfront deposits for a bridging loan, as all fees should paid when the loan closes. Always review your loan terms for any prepayment penalties.
Short Repayment Tenure
Bridging loans usually need to be repaid within 12 months or less. If you have any concerns about selling your property within this time frame, consider other financing options like a piggyback loan, which allows you to split your mortgage into two parts, a first mortgage and a second mortgage or home equity line of credit (HELOC).
Limited Legal Protections
Unlike traditional mortgage loans, bridging loans are not covered by the Real Estate Settlement Procedures Act (RESPA), which mandates lenders to provide consumers with detailed information about settlement costs. Therefore, it’s crucial to shop around for the best bridging loan terms, as they can significantly vary from one lender to another.
Bridging Loan in Practice: A Hypothetical Scenario
Let’s consider a scenario to better understand the math behind a bridging loan:
- You’re purchasing a property priced at $400,000.
- Your existing property is worth $350,000.
- You owe $150,000 on your current mortgage.
- The bridging loan provider offers to lend you 80% of your home’s value through either a new first mortgage or a new second mortgage.
In such a situation, a bridging loan converts $130,000 of your home’s equity into liquid cash, which can be used to purchase your new home while you wait for your existing property to sell.
The key difference between the two options lies in the number of mortgage payments you’ll need to handle on your existing property. With a first mortgage bridging loan, your existing mortgage balance stands paid off, leaving you with just the bridging loan to repay. In contrast, a second mortgage bridging loan leaves your existing mortgage balance untouched but adds a second lien, meaning you’ll have two separate payments until it’s paid off.
Steps to Secure a Bridging Loan
1. Assess Your Home Equity
In most cases, you’ll need at least 20% equity to qualify for a bridging loan. However, you may need significantly more equity if you need additional cash for a down payment on your new home. Remember, if your property sells for less than expected, you could stand required to repay the bridging loan balance in cash.
2. Evaluate Your Debt-to-Income (DTI) Ratio
To qualify, you’ll need to be able to handle payments on your current property and the property you’re planning to buy. If your income fluctuates due to commissions or self-employment, a bridging loan could quickly drain your savings if you’re handling three mortgage payments.
3. Improve Your Credit Score
Lenders prefer borrowers who have demonstrated responsible debt management. A high credit score will increase your chances of securing favorable rates. Some bridging loan programs may accept credit scores as low as 600, but higher scores are preferred.
4. Locate a Bridging Loan Lender
Bridging loans are a specialized product, and not all lenders offer them. You can consider the following options:
- Local Banks and Credit Unions: If you’re already banking with a local institution, inquire about their bridging loan options. Local banks and credit unions can offer personalized service and an understanding of your local real estate market.
- Non-QM Lenders: Non-QM lenders specialize in alternative mortgage products like bridging loans. These lenders offer features not allowed in qualified mortgages, like interest-only and balloon payment structures.
- Hard-Money Lenders: These are individuals or groups of investors who offer loans with short repayment terms, such as bridging loans. They may have higher interest rates but may be more flexible in terms of credit requirements. Always verify the lender’s reputation before proceeding.
Always verify the licensing credentials of any loan officer or institution you’re considering by visiting the Nationwide Multistate Licensing System (NMLS) Consumer Access website https://www.nmlsconsumeraccess.org/. You can search by the loan officer or company name to confirm they’re licensed in your state.
5. Develop a Bridging Loan Payoff Backup Plan
Securing a bridging loan can be risky if property values begin to decrease. Ensure that you can repay the loan even if you’re unable to sell your property. Failing to repay the loan within 12 months could result in foreclosure.
Bridging Loans: The Upsides and Downsides
Exploring Alternatives to Bridging Loans
Before opting for a bridging loan, consider exploring the following alternatives:
- Home Equity Line of Credit (HELOC): Functions similarly to a credit card, allowing you to borrow up to your approved limit. Many HELOCs also offer the same interest-only payment option as bridging loans.
- Home Equity Loan: This enables you to borrow against a portion of your property’s equity and receive the funds as a lump sum.
- Cash-Out Refinance: This allows you to replace your current loan with a larger mortgage and use the difference for your new home’s down payment.
- 80-10-10 Piggyback Loan: Instead of using a home equity loan or HELOC on your existing property. This option allows you to split your mortgage on the new property into two parts. With one accounting for 80% of the property’s value and the other for 10%, while making a 10% down payment.
Please note, that if you’re considering a home equity loan or HELOC for additional funds. Your property can’t listed for sale when the loan disburs.
Ultimately, the choice between a bridging loan and its alternatives should be based on your unique financial situation, goals, and the real estate market conditions.
