What is a Bridge Loan?
A real estate bridge loan is a short-term loan that allows a property owner to borrow against the equity within their existing property to purchase a new property. Once the new property is purchased the previous property is sold, which pays off the bridge loan. Bridge loans can be used for both residential and commercial real estate. The borrower may be a homeowner buying a home or a real estate investor purchasing new real estate.
Step 1 – Borrow against equity in existing property
Step 2 – Purchase new property with borrowed funds
Step 3 – Move from previous property to new property
Step 4 – Sell previous property to pay off bridge loan
Bridge Loan Definition
A commonly accepted definition of a bridge loan is a short-term loan against a borrower’s current property used to purchase a new property, at which point the original property is sold to pay off the bridge loan. The bridge loan “bridges the gap” between the existing property and the new property.
Bridge Loan Misconceptions
Some borrowers mistakenly refer to any short-term or temporary loan as a bridge loan. While the term “bridge loan” is commonly used to describe any type of temporary financing, this does not accurately represent the true definition of a bridge loan.
How Does a Bridge Loan Work? A Bridge Loan Example
A family owns a home which they currently live in. The family wishes to move to a new home, but they don’t have the necessary cash on hand for a down payment or all-cash offer. However, they do have a large amount of equity within their current home. Selling their home to raise the cash for their next home purchase would be an option although it may be costly and inconvenient.
– Scenario 1: Moving without a Bridge Loan
The family puts their house on the market to obtain the cash necessary to purchase a new property. Once the house is sold they move to temporary rental property while they look for a new home. Once they have completed the sale of a new home the family moves for the second time, from the rental property to the new home.
– Scenario 2: Moving with a Bridge Loan
The family remains in their current home while they obtain a bridge loan. Once the bridge loan has funded the family uses the bridge loan proceeds to purchase their new home. The family moves into the new home and then sells the previous home which pays off the bridge loan.
Who Offers Bridge Loans? Where to get a Bridge Loan
Many bridge loan lenders are private hard money lenders. Some credit unions and banks may offer bridge loans, but many do not as they prefer to fund long-term loans. Hard money lenders are short-term lenders and happy to provide funding for bridge loans.
Hard money bridge loan lenders have higher interest rates than conventional lenders. Although the rates are higher, hard money lenders are able to provide a much faster and easier approval and funding process. For an owner-occupied property, expect the approval and fund for a hard money bridge loan to take 2-3 weeks while a bank bridge loan may take 30-45+ days. If the real estate being used as collateral is an investment property, the hard money bridge loan can be approved and funded within 5 days if needed.
Ability to Repay Exemption for Owner Occupied Bridge Loans
A bridge loan with a term of 12 months or less is exempt from the Ability to Repay Rule. In the case of a bridge loan, the existing property that will be sold as soon as the new property is acquired serves as repayment for the loan. Income documentation from the borrower is not scrutinized as closely as it would be for a long-term owner-occupied loan.
Any other owner-occupied loan requires a borrower to meet the Ability to Repay requirement by proving their income with 3rd party documentation such as tax returns, W2s or paystubs.
Not needing to provide proof of income verification is especially beneficial for various individuals such as:
- seniors or retirees with limited income
- self-employed individuals
- those without significant income in the past few years
Flexibility of Bridge Loans
Bridge loans can be used in a variety of ways in order to help accomplish the current financing goals of the borrower. As previously stated, the bridge loan can be secured against the existing real estate owned by the borrower. A bridge loan is also able to be used in reverse order by having the bridge loan secured against the new real estate which is being purchased. If needed, a bridge loan may be secured by both the existing and new property.
Bridge Loans – Loan to Value Ratios
Bridge loan lenders typically can provide a loan to value of up to 70-75% of the current value of the property. If the property currently has an existing mortgage the bridge loan lender will want to refinance this balance and provide a new 1st loan.
Bridge Loan Rates and Fees
Bridge loan lenders are commonly private, hard money lenders as opposed to conventional lenders such banks and credit unions. Bridge loan rates from hard money lenders are frequently in the range of 8-11% depending on various factors such as the lender, location, property, requested loan to value and strength of the borrower.
The Bridge loan lender will likely charge approximately 1.5-3 points as an origination fee. For example, 2 points would be a fee of 2% of the loan amount. Some lenders may also add other expenses to the loan which may be called document fees, application fees, or processing fees. Borrowers are advised to ask upfront about all fees the lender will charge.
Prepayment Penalties – Lenders are not allowed to charge prepayment penalties for owner-occupied property due to the current federal regulations. Prepayment penalties may or may not be charged for bridge loans against investment property.
While bridge loan rates from hard money lenders are higher than conventional bank loans, the speed of approval and funding are often worth the added cost. Because bridge loans are written for 12 months or less, the borrower only has the higher interest rate for months, not years.
How to Qualify for a Bridge Loan
Qualifying for a bridge loan from a hard money lender is simple. The borrower first needs to fill out a loan application provided by the bridge loan lender. The borrower will need to have enough equity in their property based on the requested loan amount as well as enough cash on hand to make the monthly mortgage payment while the bridge loan is outstanding.
As stated previously, the Ability to Repay Rule does not apply to bridge loans. Therefore, income documentation and qualification based on debt to income ratio is not as important compared to a permanent owner-occupied loan. As long as the borrower has sufficient equity, many hard money bridge loan lenders are able to overlook poor credit and other negative issues on a borrower’s record such as loan modifications, short sales, foreclosures, a deed in lieu or bankruptcies.
For more information on bridge loans visit our Bridge Loans page or contact North Coast Financial now.