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How to Use Bridge Loan to Buy a Home
A bridge loan is a short term loan used to purchase a property. A bridge loan is typically refinanced or paid off when the property is sold, prior to the end of the loan term. It is called a bridge loan because it serves as a financial bridge from the time you buy a home until when you either refinance it with a permanent mortgage or pay it off.
There are several key points to understand about how bridge loans work. First, the loans are typically one-to-two years in length, so they are a short term financing option as compared to a 15 or 30 year mortgage. In short, bridge loans are meant to be temporary and paid off before you reach the end of the loan term. In most cases, it is best to payoff a bridge loan as soon as possible.
Second, most bridge loans are structured as interest only loans with a balloon payment at the end. With an interest only mortgage, you pay no principal which lowers your monthly loan payment. This feature is designed to make the bridge loan more affordable for borrowers.
It is important to highlight that with an interest only loan, you do not pay down the principal balance when you make your monthly payments so the full loan amount is due at the end of the term. For example, if you obtain a one year, $100,000 bridge loan, you owe the lender $100,000 when you decide to pay back the mortgage, even if you have made several monthly payments. In other words, your loan balance never changes.
Bridge loans are not cheap and typically costs borrowers significantly more money than a traditional mortgage. Bridge loan rates are typically 2.5% - 3.5% higher than the rate for a standard mortgage and bridge loans also charge higher fees. Bridge loan rates depending on several factors including your credit score, loan-to-value (LTV) ratio, the property being financed and the purpose of the loan. Borrower should shop several lenders to find the bridge loan with the lowest interest rate and closing costs.
Although they usually have short lengths, some bridge loans require that borrowers pay a prepayment penalty if the loan is paid off within a specified time period, typically six months. Make sure to review your loan terms carefully to identify a prepayment penalty or other charges before moving forward with a bridge loan.
There are multiple reasons to use a bridge loan to buy a home. The most common use case is for a bridge loan is when a you want to buy a new home but you have not sold the property you currently own so you do not have sufficient funds for a down payment.
In this situation, the homebuyer uses a bridge loan to pay for the down payment for the new property and then pays off the loan with the proceeds from the sale of of the property they currently own. In this scenario, the borrower must be able to afford the bridge loan payments plus the payments for any mortgages on their current and new properties, so it can be very expensive. Having multiple mortgages also involves higher risk for borrowers and lenders which is one of the reasons bridge loan rates are higher.
Another reason to use a bridge loan to buy a home is if you believe your financial situation or credit profile will improve in the future. For example, you may want to purchase a home today but a low credit score or limited employment history prevents you from qualifying for a standard mortgage. You can use a bridge loan to buy the property now and refinance the loan with a permanent mortgage in a year after you credit score improves or you have sufficient employment history to get approved for a traditional mortgage. So a bridge loan may be a good option if you cannot qualify for a mortgage but you do not want to wait to buy a home.
Bridge loans are also frequently used by property flippers. For example, if you want to buy a property, renovate it and then sell, or flip it, you could use a bridge loan to finance the purchase. So a fix & flip loan is one type of bridge loan. House flippers like bridge loans because the interest only payments keep their costs down during the property renovation phase. Plus, in the best case scenario, you flip the home before the bridge loan expires.
A bridge loan is usually secured by a single property, which is the lending structure typically used by house flippers. In the case where a homebuyer would like to buy a new home but they have not sold their current home, the bridge loan may be structure as a second mortgage on the existing property but the mortgage is collateralized by both properties.
A bridge loan that is secured by multiple properties provides the lender with a significant amount of protection in the event that you cannot repay the loan but this also exposes you to the risk that you lose multiple properties. Be sure to understand the potential downside of obtaining a bridge loan that is secured by two properties.
It is also important to point out that bridge loans usually have a loan-to-value (LTV) ratio requirement of 70% or lower, which means the loan amount cannot be greater than 70% of the value of the property being financed. The lower LTV ratio limit is lower than a standard mortgage and helps mitigate the risk for lenders.
Bridge loans can be challenging to find as they are typically offered by smaller, local lenders or hard money lenders, which are also known as private money lenders. Hard money lenders charge significantly higher interest rates and closing costs than traditional lenders. Given the costs involved, we recommend that borrowers work with one lender on both the bridge loan and the permanent mortgage, if possible, as this can potentially reduce expenses and streamline a complicated process.
Use the FREEandCLEAR Lender Directory to search by lender type and loan program including private money lenders that offer alternative mortgage programs.
Sources
"B3-4.3-14, Bridge/Swing Loans." Selling Guide: Fannie Mae Single Family. Fannie Mae, April 1 2009. Web.
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