Personal Finance

What Is a Bridge Loan?

Nov 20, 2018

In today's competitive real estate market, buying a home can be challenging. Inventory levels remain near historic lows and supply has not been able to meet continued demand. Buyers must overcome many challenges for an offer to be accepted, secure financing, and get to closing.

Sellers can be very selective and pick and choose from multiple offers in many cases. Some tend to choose all cash offers over those with mortgage contingencies, some require buyers to waive appraisal contingencies, and others require fast closings.

In response, buyers have had to become more resourceful and find new ways of securing their future home. One way buyers do this is with a bridge-to-sale loan.

A bridge loan is a short-term loan taken out by a borrower to temporarily finance the purchase of a new property. The loan is secured by some type of collateral, most often the property being sold or the real estate being financed by the loan.

How do bridge loans work?

Bridge loans are short-term loans offered by select banks and lenders. They typically last for at least six months but can often be extended up to a full year. These loans can be structured in different ways depending on the borrower's need.

These loans are available for both residential and commercial real estate purchases. They may not require minimum credit scores and debt-to-income ratios, as lenders focus more on the loan’s viability and the borrower's ability to repay it.

Interest rates on bridge loans are often higher than average fixed-rate mortgage products, usually by around 2%. However, the rates can vary widely along with the loan terms and fees. Borrowers might get better rates and terms if they obtain the bridge loan and the long-term mortgage from the same lender.

Payment structure can also vary by lender. At Axos, we collect 12 months of payments upfront, which is then held in a deposit account. Interest-only payments are then made from this account for the term of the loan. A balloon payment is then made at the end of the term or when the property sells.

What is the benefit of a residential bridge loan?

Without a large financial cushion, many borrowers don't have enough money to make a down payment on a new home before the sale of their old home. A bridge loan is used to span the time between the purchase of the new property and the sale of the old property.

The loans are often set up in two ways. One option is for the loan to be large enough to pay off the mortgage on the old home and be used for a down payment on the new home.

Another option is to use the loan only for a down payment on the new home. The collateral for the loan is often the home that is for sale. When the home sells, most borrowers use the proceeds to pay off the bridge loan.

A bridge loan may be useful for several reasons:

Alleviates the "sell-before-you-buy" dilemma.
Removes contingencies from the equation.
Provides increased leverage in a competitive housing market.

1. Alleviates the "buy-before-you-sell" dilemma.

The stress of coordinating the buying and selling transactions can be eliminated with a bridge loan. Instead, the buyer can focus on purchasing the property they want without the restrictions of having to sell their old property first.

A bridge loan gives a borrower time to move into a new home, get settled, and then focus on selling the old one. When moving to a new community, this type of loan can alleviate the need for a buyer to temporarily rent a property while waiting for the old home to sell.

2. Removes contingencies from the equation.

Another advantage of a bridge loan is that it allows the buyer to avoid a contingent offer that relies on the sale of another property. This can put the buyer at a disadvantage because many sellers won't accept a contingent offer of this type.

Removing this contingency through a bridge loan can make the buyer's offer more attractive.

3. Increased leverage in a competitive housing market.

In a competitive housing market, a bridge loan can allow the buyer to move swiftly with an offer. If the seller is prioritizing a quick sale, a borrower that can move forward immediately without waiting for their old property to sell often has leverage over other buyers.

Weighing the Rewards vs. Risks of a Bridge Loan

Bridge loans offer both benefits and risks. The main risk is that the borrower's old property might not sell within the loan term. However, this can be mitigated by having a binding contract of sale on the old property.

Researching the local housing market can help borrowers make an informed decision by understanding the average time it takes homes to sell. Negotiating a 6-month extension on the bridge loan may be an option based on the findings.

Borrowers may find they obtain better terms when working with a single lender instead of using two different lenders. The borrower will want to carefully review all the terms of the loan and understand if there are prepayment penalties.

What are alternatives to bridge loans?

There are many alternatives to a bridge loan. Two that don't require the sale of investments for a down payment include a Home Equity Line of Credit and the use of pledged assets. A third option is cross-collateralization, which uses the equity from an existing property that the borrower doesn’t immediately plan to sell.

Home Equity Line of Credit (HELOC)

If a borrower has significant equity in the old property, a HELOC could be an option. Based on the borrower's maximum draw amount, they may be able to use the available money from their HELOC for the down payment on the new home. However, this is not an option if the old property is listed for sale.

In most cases, the borrower will need an existing HELOC or will want to apply for one before putting their house on the market. Few lenders will give borrowers a line of credit once the property is on the market.

Financing a Down Payment with Pledged Assets

A less common down payment option is a pledged asset mortgage. It allows a borrower to leverage their stocks and liquid assets to help lower the loan-to-value ratio (LTV) of their new mortgage.

Instead of a larger down payment, the borrower pledges assets such as stocks, bonds, CDs, savings, or mutual funds to use as collateral on the loan. Because the borrower isn't making a down payment, they pay interest on the full price of the property.

Increase Buying Power with Cross-Collateralization

If a borrower doesn’t have near-term plans to sell their existing property, they can also explore a cross-collateralization loan. This is a portfolio mortgage program that allows the borrower to add a second property as collateral for a mortgage.

The result is one loan for the two homes. The extra equity minimizes the amount of cash that’s needed for downpayment. If desired, the borrower can later sell one of the properties or refinance to remove the additional home from the loan.

How do I start my bridge home loan journey?

In the right situation — when a borrower doesn't want to wait for the sale of another property, would like to avoid contingencies, or seeks to gain a competitive edge in a seller's market — a bridge loan can be a viable option.

The first step is to compare loan options and scenarios and find a lender you trust. Like any loan, a bridge home loan comes with rewards and risks. Exposure can be reduced when the borrowers are confident their property will sell and have a plan in case it doesn't.

Our team at Axos Bank is here to help navigate the process to bridge the gap whether you’re a developer, mortgage broker, or homebuyer.