You probably already know about a classification of financing called “hard money” loans. A hard money loan is backed by an asset. The borrower secures the loan using some form of property. Hard money loans are issued by private firms and the interest rate they carry is generally higher than more traditional loans. This is because the lender is taking more of a risk in issuing the loan, and this understanding is shared by both parties. Such a loan could be used for a number of different things. Hard money loans offer value to customers who cannot secure more traditional means of financing for a project or purchase. Collateral in the form of the asset offered to secure the loan therefore reduces risk for the lender and, the greater the collateral, the more likely the lender is to be able to approve the loan. In a hard money loan, the loan-to-value (LTV) ratio is determined using the purchase price of the property in question (the amount that the lender could realize if the collateral were seized and sold) versus the amount loaned to the borrower.
A hard money loan could also be one that involves a foreclosure, or a situation in which a mortgage is in arrears. If this is the case, then the loan may very well involve a form of hard money loans called bridge financing. The difference between bridge financing and a hard money loan, however, is that a bridge loan is an even shorter-term loan involving commercial properties. The interest rates are higher and the total amounts are typically higher. Bridge financing helps bridge the gap between the time an investor cannot get more traditional, “permanent” financing, and the time that he or she can secure this more permanent financing because the transitional nature of the securing asset has become more stable. For example, a bridge lender might give a borrower a loan against a piece of property, but the borrower has to agree to buy back the property within a relatively short period of time. Failure to do so results in transfer of the real property from the borrower to the lender, which compensates the lender for the money paid out. All of this occurs because the borrower cannot get credit with a more traditional lender.
Bridge financing may be just the solution you need, depending on the state of the asset with which you would like to secure a hard money loan. Colin Robertson, writing in The Truth About Mortgage, explains, “A ‘bridge loan’ is basically a short term loan taken out by a borrower against their current property to finance the purchase of a new property.
Also known as a swing loan, gap financing, or interim financing, a bridge loan is typically good for a six month period, but can extend up to 12 months. Most bridge loans carry an interest rate roughly 2% above the average fixed-rate product and come with equally high closing costs. Bridge loans are generally taken out when a borrower is looking to upgrade to a bigger home, and haven’t yet sold their current home. A bridge loan essentially “bridges the gap” between the time the old property is sold and the new property is purchased. Many purchase contracts have contingencies that allow the buyer to agree to the terms only if certain actions occur. For example, a buyer may not have to go through with the purchase of the new home they are in contract for unless they’re able to sell their old home first. This gives the buyer protection in the event no one buys their home, or if nobody is willing to buy the property at the terms they desire. When a seller won’t accept the buyer’s contingency, a bridge loan might be the next best way to finance the new home.”
He goes on, “A bridge loan can be structured so it completely pays off the existing liens on the current property, or as a second loan on top of the existing liens. In the first case, the bridge loan pays off all existing liens, and uses the excess as down payment for the new home. In the latter example, the bridge loan is opened as a second or third mortgage, and is used solely as the down payment for the new property. If you choose the first option, you likely won’t make monthly payments on your bridge loan, but instead you’ll make mortgage payments on your new home. And once your old house sells, you’ll use the proceeds to pay off the bridge loan, including the associated interest and remaining balance. If you choose the second option, you’ll still need to make payments on your old mortgage(s) and the new mortgage attached to your new property, which can stretch even the most well-off homeowner’s budget. So make sure you’re able to take on such payments for up to a year if necessary. Most consumers don’t use bridge loans because they aren’t necessary during housing booms and hot markets. For example, if your home goes on the market and sells within a month, it’s typically not necessary to take out a bridge loan. But now that things have cooled off, they may become a bit more common as sellers experience more difficulty in unloading their homes.”
It’s a fact that a bridge loan can be risky. The borrower is basically taking on a loan that has a high interest rate, and if the property doesn’t sell within the period allocated for the bridge loan, that could mean real financial trouble. However, borrowers usually don’t have to pay interest in the remaining months of that time period if their home is sold before the term of the bridge loan is complete. Robertson recommends trying to work out a deal with a single lender that provides both the bridge loan and the more permanent financing that kicks in when the transition period is completed. You will probably get a better deal overall. While there are alternatives to bridge financing, it is probably the case that bridge financing is what you can qualify for, and therefore that is why you are considering it.
Michael D. Larson, writing for Bankrate, explains that bridge financing eases the transition from one home to another, but that this easing comes at an eventual cost. “They can save the day for home buyers in a pinch, but people looking for a ‘bridge loan’ to span the gap between the sale of an old home and the purchase of a new one should ask if the cost is worth it. Experts say it almost never is, and people would be better off staying put until they’ve unloaded their first residence. If that’s impossible, they warn, be prepared to shoulder a heavy burden. …A tool used by movers in a bind, bridge loans vary widely in their terms, costs and conditions. Some are structured so they completely pay off the old home’s first mortgage at the bridge loan’s closing, while others pile the new debt on top of the old. Borrowers also may encounter loans that deal differently with interest. Some carry monthly payments, while others require either up-front or end-of-the-term lump-sum interest payments. Most share a handful of general characteristics though. They usually run for six month terms and are secured by the borrower’s old home. A lender also seldom extends a bridge loan unless the borrower agrees to finance the new home’s mortgage with the same institution. As for rates, they accrue interest at anywhere from the prime rate to prime plus 2 percent. …Real estate market risks can exacerbate the danger…”
Larson goes on, “Whether a homeowner takes a bridge loan or a hybrid stand-in, however, a significant amount of new debt will end up being added to the pile. …But even though they aren’t the best deal, bridge loans or other short-term mortgage financing products may be necessary when home buyers land in tight spots, lenders say. There will always be people relocating for work without much advance notice, trying to keep others from beating them to the punch on a property, or needing help with the expensive up-front costs of buying a new home before their old one sells. …Bridge loans nevertheless remain relatively obscure in a lending landscape dominated by more widely publicized home equity loans and lines of credit. A fast-churning real estate market also eases the demand because it shortens the amount of time it takes for people to sell their homes…”
Michele Lerner, meanwhile, in Realtor.com, explains, “Most buyers try to time the purchase of their next home and the sale of their current home so they can coordinate nearly simultaneous settlements, but the reality is that sometimes one end of the chain of transactions happens faster or slower than expected. [Realtors]… can help you decide whether to place your home on the market before or after you start searching for your next home, but many buyers end up needing to finance more than one home for a few days or weeks or even a few months. If your budget is tight and you’re more concerned about your ability to sell your home than about finding one to buy, then it may be best to finalize the sale of your home before you make an offer on another property. The risk is that you may have to move into temporary housing in between homes, but you may be able to negotiate with your buyers to rent back your home until you can move into your next residence. If you decide to go ahead and buy a home before selling your current home, you can discuss your financial choices with a lender. Buyers with the cash for a down payment and enough income to make the payments on two homes at once may qualify for a regular mortgage on their new home, but if you lack the funds for this you may have to look into an alternative.”
Bridge financing, Lerner explains, are sometimes called “wrap” or “gap” financing, and this is based on their nature. These are short-term loans, temporary financing that wraps the payments for your current home into your next home in one loan (in the case of residential real estate).
Will Carpenter sums it nicely when he explains that bridge financing is basically a “loan anticipation” loan. It is, as he puts it, “a short-term loan made while waiting for the completion of long-term permanent funding. Its principal advantage is time; you don’t have to wait to achieve a desired goal. You leverage the equity in your current home or retirement package to move you into your dream home weeks or even months ahead of mortgage approval. The type of security may be personal assets or real property. Liquid assets — stocks, a certificate of deposit or a stash of gold bars — are best because the bank can convert them quickly if you default. A home equity loan, where the lender uses your equity as security, is another source of bridge financing. Bridge loans work for [businesses and non-businesses] as well. A bridge loan can help you move your idea for a new product or service from concept to sales without delay. Using your business’s assets as security, a bridge loan not only saves time but it might buy you time to capture a market share while your competitors are struggling to gain financing. … The time factor is important in real estate transactions, particularly those involving a contract that specifies a deadline. A mortgage company and title insurer will complete their due diligence before they decide whether or not to issue a check. While a bridge loan allows you to move to closing more quickly, it does require prudence.”
Infiniti Funding can provide you with the bridge financing you need to bridge the gap between your current situation and the more permanent financing you require. Contact us today to discuss your specific financial situation.