A bridging loan is quite different from a standard bank loan. Read on to discover what is a bridging loan, and more here.
More than five million homes went on sale across the United States in 2018 alone.
Buying a home has been an abiding element of the American dream. In pursuit of this vision, many homeowners rely on bridge loans to buy a new house while putting up their existing homes for sale.
If you’re wondering, “What is a bridging loan?” Then here is a detailed guide to help you learn more about this type of financing.
What Is a Bridging Loan?
A bridge loan is a temporary form of credit that helps you, the homeowner, purchase a new home while you go about selling your current house.
Bridge loans are short term, meaning they run for between one to 18 months and are secured by the property you’re selling.
How a Bridge Loan Works
When you approach a money lender for a bridge loan, they will combine the existing mortgage and the new mortgage for the move-up property. The lender will then offer you a bridge loan based on the value of the combined mortgages.
Typically, lenders will give you up to 80% of the loan-to-value ratio of the combined mortgages. That implies you need to have built up a significant equity position on your current house or have extra cash at hand.
A bridge loan is repayable in full at the end of its tenor. Since the monthly interest is included in the loan amount, you don’t have to make any payments during the loan’s term.
That gives you the flexibility you require to dispose of your current property and take up a new one.
How to Use a Bridge Loan
Bridge loans in real estate have various uses depending on the need at hand.
You can use it to settle the mortgage on your existing property and place a down payment on the move-up house.
Other homeowners choose to take the loan out as a new lien whose proceeds sink only into the down payment of the new house.
Let’s say you want to use the bridge loan only to pay the down payment on the new house and add it to your existing debt. Furthermore, let’s imagine that you have built p $140,000 worth of equity on your current $200,000 home.
If you take a $70,000 bridge loan, you will only direct the funds towards the down payment for the new home. Meanwhile, you will still be responsible for the $40,000 left on the mortgage on your old house.
Now let’s say you want to use the bridge loan for paying the mortgage on your old home plus a down payment on the new house.
If we take our previous scenario, you will pay $40,000 of the $70,000 from the bridge loan to clear the old home’s mortgage.
With the remaining $30,000, you can then pay for the new house’s down payment (less any necessary fees).
Some property owners end up using the equity they have in their property to access a bridge loan. In effect, the credit helps them convert their equity into liquidity they can use to buy another property quickly, move offices, among other uses.
The Structure of an Average Real Estate Bridge Loan
The terms, fees, and rates you can get for a real estate bridge loan will vary depending on the lender. However, on average, there is a range you can expect on the different aspects of the loan’s structure.
Regarding the interest rate, expect to pay up to the current market rate plus approximately 2% or more depending on the lender.
The average lifespan of each bridge loan will span six to 18 months.
You can also expect to land a loan-to-value ratio of 80% with that figure moving up in some cases.
Several fees are part of the bridge loan, of which you will need to foot. These are origination, appraising, escrow, and title fees. If you decide to pay back your loan in full ahead of the agreed schedule, some lenders may impose a prepayment penalty.
How the lender will structure your repayment terms will depend on the type of bridge loan you take. If you opt for an amortized one, you will be subject to fixed monthly payments.
An unamortized bridge loan will call for you to pay a one-time amount at the end of the tenor or if your old house sells before the loan term runs out. During this period, the loan will be accruing interest.
Alternatively, you can settle for an unamortized bridge loan where you only pay interest each month. At the end of the tenor, you’ll make a balloon payment.
However, if your old house sells before the term of the loan ends, you will be required to make the down payment.
Factors You Should Weigh When Getting a Bridge Loan
As with any form of credit, there are some issues you should assess to determine if a bridge loan is right for you. These include:
1. The Total Cost
It’s easy to get lost in looking at the interest rate of bridge loan lenders that you forget to assess how much you’ll be paying back in full.
Some lenders who realize this fact will offer low-interest rates but stack up the exit fees, management charges, among other hidden costs.
Break down the total associated costs for each provider to identify the option that best works for you.
2. Can You Sustain Repayment?
The most significant risk that comes with taking a bridge loan is whether you’ll make repaying the lump sum amount when the term ends. Will your exit be viable given the structure you opt for and the fees involved?
If you want to take out the bridge loan to purchase a new home, ensure the term is long enough for you to manage selling your old home to fund the repayment.
Don’t Let Selling Your Home Keep You From Buying Another One
Owning the roof under which you lay your head is a precious part of the American dream.
To achieve this aspiration, you can rely on a bridge loan to help you buy a new home as you look for a buyer for your current house. Before you sign any deal, discover the right answers to the question, “What is a bridging loan?” to ensure that the loan is suitable and sustainable for you.
Are you passionate about making your home a better space and investment for your loved ones? Check out more of our content for insightful tips, tricks, and ideas that add value to your home.