Homeowners looking to purchase a new home often need to sell their existing home in order to free up cash which typically isn’t a suitable solution. This would require moving out of the existing home to temporary housing and then moving again once the new home is purchased. Moving twice is an inconvenient and expensive hassle.
In this type of situation, the homeowner is generally faced with three options: a bridge loan, a home equity line of credit (HELOC) or a home equity loan.
Bridge loans are short-term financing tools that allow a homeowner to borrow against the equity within their existing home in order to purchase a new home. Once the new home is purchased, the previous home is then sold in order to pay off the bridge loan. Bridge loans have terms of 12 months of less. Bridge loans are most easily obtained from hard money lenders also called private money lenders as they have fewer requirements than banks and they are able to approve and fund bridge loans quickly.
Bridge Loan Advantages
Bridge loans can be obtained without verifying income
For owner occupied property, current federal government regulations require all lenders to verify a borrower’s income and ensure that their debt to income ratio will remain below a certain level. This is referred to as the “Ability to Repay” requirement. Bridge loans which have a term of 12 months or less have a special exception from Ability to Repay rules since the sale of the existing home serves as the repayment for the loan.
Bridge Loans for Seniors and Retirees – Being able to obtain a bridge loan against an owner occupied property without sufficient income is especially helpful for seniors and retirees who may have limited income in retirement. A bridge loan may be the only option for seniors who need to move their primary residence with the help of financing.
Fast Approvals and Funding
Bridge loans from hard money lenders can be approved the same day the borrower’s completed application is received. Funding for owner occupied bridge loans take 2-3 weeks due to the current federal regulations. Funding for non-owner occupied investment property bridge loans can take as few as 3-5 days.
Hard money bridge loans can be obtained against property that is currently listed for sale
Hard money lenders are in the business of making short-term loans, so providing a loan to a borrower that will pay off within a year is acceptable. Banks and credit unions generally will not provide loans against a property on the market. Long-term loans which payoff within a year are not desired by banks and other institutional lenders.
Hard money bridge loans are very flexible
Hard money bridge lenders do not have the same stringent criteria as banks. A hard money bridge loan can be secured against the existing home, the new home being purchased or both homes. As long as the borrower has sufficient equity, hard money lenders have the flexibility to help the client achieve their real estate goals.
Bridge loans are available for borrowers with less than perfect credit
While banks and credit unions focus on income and credit scores, hard money lenders are primarily concerned with the value of the property and borrower’s equity in the property. As long as the borrower has enough equity within their property they will likely be able to obtain a bridge loan.
Bridge Loan Disadvantages
Bridge Loans have higher interest rates and transaction costs
Interest rates and transaction costs for bridge loans from hard money lenders are often higher than what is available from a bank. While the costs are higher, the convenience and speed of funding generally makes up for the added costs.
Bridge loans are for short-term use
Bridge loans must have a term of 12 months of less for the exemption from the Ability to Repay requirement. Purchasing a new property and selling an existing property within 12 months should be a sufficient amount of time but some homeowners may need additional time.
Bridge loans are difficult to obtain from institutional lenders
Few institutional lenders such as banks and credit unions are interested in short-term loans such as bridge loans. If a borrower is able to obtain a bridge loan from a bank the cost will likely be lower but the approval and funding process will be much longer when compared to a hard money lender.
Home Equity Lines of Credit (HELOC) and Home Equity Loans
HELOCs and home equity loans are financing tools that allow a homeowner to borrow against the equity within their primary residence. The borrower often keeps their existing mortgage in place and the new equity loan is in 2nd position. If the property current has no mortgage, the new equity loan will be in 1st position. These loans are available from lenders such as banks and credit unions. Loan terms of 10-20 years are common for these types of loans.
HELOC and Home Equity Loan Advantages
Lower rates and fees than bridge loans
HELOC and Home Equity Loan interest rates are often 1-2 percent points higher than regular home mortgages. Some lenders may offer these loans with little or no loan origination fees.
Combined loan to value ratios of up to 70-80%
It is common for HELOC and home equity loans lenders to offer up to a 70-80% combined loan to value ratio (CLTV). To calculate the potential loan amount for the equity loan, multiply the maximum CLTV percentage by the value of the property and then subtract the current balance of the existing mortgage.
HELOC and Home Equity Loan Disadvantages
Longer loan approval and funding timelines
The loan application approval process from a bank or credit union may take a couple weeks once submitted. Once approval has been received, funding for the HELOC may take up to 30 days. Traditional lenders typically don’t have an emphasis on funding the loan as quickly as possible.
The borrower must prove their income and have good credit
Traditional lenders are sticklers when it comes to credit. Current federal regulations require borrowers to prove their income in order to qualify for an owner occupied loan. The borrower’s debt to income ratio must be in a reasonable range. Any recent issues on the borrower’s record such as foreclosures, bankruptcies, short sales, or loan modifications may prevent the lender from approving the loan.
HELOCs and home equity loans are not available for homes currently on the market
Banks and credit unions generally do not provide loans against real estate that is currently listed on the market. When a property is listed for sale it generally tells the bank any loan provided against the property will be short-lived. Short-term loans are not desired by banks since they want the long term servicing income from the loan. The borrower must plan ahead and secure a HELOC/home equity loan against their home prior to putting up for sale.
Home Equity Line of Credit (HELOC) vs. Home Equity Loan
HELOCs are typically preferred because they are initially interest-only and interest is only paid on the amount of funds borrowed from the credit line. Home equity loans require the borrower to make payments on the full loan amount once the loan is funded.
HELOCs work in a similar way to credit cards as there is a credit limit which can be borrowed against, paid back and then borrowed against again. Once a home equity loan is paid off the borrower will have to reapply for another loan. HELOCs provide the borrower with more flexibility.