When the asset you possess is currently in state of transition or there is some other financial condition that is temporarily stopping you from obtaining more permanent financing for a transaction, bridge loans may be just the thing to bridge that gap between one form of financing and the next. But are bridge loans right for you? What are bridge loans, and how can they help? The answers are not terribly complicated, but there are certain things about bridge loans that you have to consider before you decide whether obtaining bridge loans as a form of temporary financing is the right form of financial solution for you or your business interests.
Paul M. Fowler describes bridge loans as loans that are short-term, intended to bridge the gap between two longer-term financing loans. “Companies use bridge loans when necessary to cover capital shortfalls that may otherwise occur when the company must repay a loan before it has had time to obtain a new long-term loan,” Fowler goes on. “Companies can use bridge loans for a variety of purposes. The most common types of bridge loans include operating capital and mortgage bridge loans. For instance, if a company’s mortgage loan on the company’s office space comes due before the company finds a suitable replacement long-term mortgage loan, the business may acquire a bridge loan to pay off the current mortgage. Then, when the business acquires the new long-term loan, it will pay off the bridge loan. …Companies can generally more easily qualify for a bridge loan than for more long-term financing options. Lenders involved in the bridge loan industry understand that bridge loans simply provide gap financing and are not long-term solutions for the businesses, which means companies are generally more willing to pay a higher interest rate or higher loan origination fees. Bridge loan lenders customize bridge loans to suit a variety of different needs for businesses. The whole idea behind a bridge loan is that it is easy and quick to obtain, unlike a traditional long-term commercial loan.”
Fowler goes on to explain that bridge loans, as attractive as they seem, are also relatively expensive, so you have to do your homework to make sure they are what’s right for you. “It is a universal truth in the financing industry that the quicker company can access money, and the easier it is for the company to qualify for the money, the higher financing costs the company will pay,” he writes. “Just as a payday loan carries a much higher interest rate than a long-term mortgage or auto loan, so too does a bridge loan carry much higher financing charges that a more conventional long-term loan. The higher financing costs explain why companies use bridge loans as only a short term solution, instead of as a long-term financing tool. …Another benefit of a bridge loan for a company is that the company can generally pay off a bridge loan at any time without a prepayment penalty. This is different than most commercial mortgage loans, in which the borrower might pay a significant penalty for paying off the loan early. Bridge loans generally carry no prepayment penalty, which makes them a flexible option for companies looking to obtain a long-term loan.
Charles Infosino of Demand Media explains, “Just as it is easier to get a job when you have a job, it is easier to buy a home when you already own a home – if you get a bridge loan. However, just as you need to leave your current job for a new job, with a bridge loan, you are required to sell your existing home to finance the purchase of your new home. Bridge loans allow homeowners to use up to 80 percent of the value of an existing home for sale as a down payment for the new home. A bridge loan provides several advantages to people wishing to transition to new homes. …A bridge loan is a short-term loan that acts as a bridge between the loan on your existing home that you are selling and the new home that you are buying. It provides funding for the down payment on a new home by borrowing off the equity in the existing home. …A bridge loan saves time because it is designed to generate funding for a new home purchase when the existing home has been sold, but settlement will not occur until after the new home purchase is complete. The great benefit of the bridge loan is that it allows you to use the net equity from the existing home sale, prior to it being realized, as down payment for the new home. Another time-saving benefit is that you can move into your new home over several days, rather than moving immediately from the old to new home on the closing day.”
Infosino goes on to explain that most mortgages make borrowers comply with a long-term option structure. Bridge loans don’t do that. With bridge loans, the borrower can repay the bridge loan before or after securing more permanent means of financing under better terms. …Most mortgages force borrowers into long-term options. However, with a bridge loan, borrowers have the choice of repaying the bridge loan either before or after the permanent financing is secure. When a borrower repays the loan before, she can either repay it in full or in structured payments over a fixed time period. If you make your payments on time, your credit rating will improve, which can make you eligible for a loan that you normally might not qualify for. When the borrower chooses to repay the loan after the financing is secure, a portion of it is used to pay the off the bridge loan. …Interest rates generally run 0.5 percent to 1 percent higher for bridge loans than they do standard, 30-year fixed-rate mortgages. Borrowers must pay interest on the bridge loan for six months out of the proceeds from the existing home sale. Since there are two home sales occurring, selling one home and purchasing another, two closings with individual closing costs are required.”
William Pirraglia, meanwhile (also of Demand Media) explains that mortgage bridge loans “are graphically accurate terms. When you buy another house before selling your current one, you often face income and cash challenges to complete your new home purchase. Enter bridge loans, which allow you to buy your new home before you sell and close on your current residence. This financing builds a “bridge” between closing on your new home and the sale of your current house. …You might think that a home equity loan is cheaper and a better alternative to bridge financing. You’d be correct, but most lenders will not give you a home equity loan when your house is actively for sale on the market. You won’t have the opportunity to take advantage of typically lower home equity interest rates and closing costs. Properly structured bridge loans can help you disregard the typical home equity loan benefits. …Bridge loans are temporary, bridging the gap between closing the purchase of your new home and selling your current house. Bridge lenders take your current home as collateral, with these loans acting as a second mortgage or an equity loan, to give you the down payment for your new home. Bridge loans allow you to complete the purchase of a new home before you have the proceeds from the sale of your current home without causing you to default on your purchase contract or destroy your bank account.”
Pirraglia explains that you’ll own two homes for a short period of time, but then you’ll be able to close on the new one. The bridge loan lender will advance you funds representing your equity and future cash proceeds from your current home sale. As soon as your current home sells and closes, your proceeds will pay off the bridge loan. You’ll pay interest from the day you got the bridge loan until you sell your home and pay off the loan.
“Monthly payments are seldom required on bridge loans, at least for a few months,” he explains. “There are normally fees, giving your lender an opportunity to earn income above interest. You may need to pay one-half to one point — one point equals 1 percent of the loan amount — for this financing. There may be other closing costs, such as escrow or recording fees, to close this temporary loan. If the sale of your current house takes a while, you may need to make payments on two mortgages for a few months or pay more interest than you might like.”
Among the liabilities of bridge loans he highlights are the fact that interest and fees are higher than with alternatives and equity loans. In the case of two homes cited earlier, the borrower may find him or herself making two mortgage payments, at least for a time. Fees may seem very high, considering that it’s a short-term financing option. Pirraglia encourages would-be investors to shop around for the most attractive deal.
Corey Curwick Dutton of Mortgage Professional America says that bridge loans benefit investors in three key ways. “Bridge financing allows investors to make their money go further. For example, if two properties come together at the same time, an investor can purchase both properties using a bridge loan on each purchase. Bridge financing removes partners or family members from a deal. Investing with family members or business partners can be tricky. Bridge loans can remove other partners from the equation, allowing an investor more freedom and flexibility with a newly acquired asset. Bridge loans fund faster than bank loans. If an opportunity is good, it won’t last long. Bridge loans have less requirements than bank loans and thus close quicker. Bridge financing allows investors can grab a fleeting opportunity before another investor snatches it up.”
Elizabeth Weintraub, a home buying and selling expert, meanwhile, explains that bridge loans are gaining in popularity. “When a home buyer is buying another home before selling an existing home, two common ways to find the down payment for the move-up home is through financing either a bridge loan or a home equity loan (or home equity line of credit). Generally, a home equity loan is less expensive, but bridge loans contain more benefits for some borrowers. In addition, many lenders will not lend on a home equity loan if the home is on the market. Smart borrowers will compare the benefits between the two loans to determine which is a better fit for their particular situation and plan ahead before making an offer to purchase another home. …Bridge loans are temporary loans that bridge the gap between the sales price of a new home and a home buyer’s new mortgage, in the event the buyer’s home has not yet sold. The bridge loan is secured to the buyer’s existing home. The funds from the bridge loan are then used as a down payment on the move-up home. …Many lenders do not have set guidelines for FICO minimums nor debt-to-income ratios. Funding is guided by a more “make sense” underwriting approach. The piece of the puzzle that requires guidelines is the long-term financing obtained on the new home.”
Weintraub goes on, “Some lenders who make conforming loans exclude the bridge loan payment for qualifying purposes. This means the borrower is qualified to buy the move-up home by adding together the existing loan payment, if any, on the buyer’s existing home to the new mortgage payment of the move-up home. The reasons many lenders qualify the buyer on two payments are because most buyers have an existing first mortgage on a present home,
the buyer will likely close the move-up home purchase before selling an existing residence, [and] for a short-term period, the buyer will own two homes.”
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