Consumer Bridge Loan Deep Dive
When I first heard about the consumer bridge loan 6 years ago my first thought was “Oh, it’s a bridge loan, I know what those are.” I was wrong. What I didn’t know is that several years ago the Consumer Finance Protection Bureau put in place numerous rules and restrictions on bridge loans being made to consumers. This “Deep Dive” will explain all the ins-and-outs of the new Consumer Bridge Loan.
If you are seriously considering a bridge loan, I strongly urge you to read this entire section. Getting a consumer bridge loan is a major financial transaction and you should be well-informed before moving forward.
The consumer bridge loan is one loan secured by two properties, the departing residence and the new home that you are buying. Instead of using cash, a consumer bridge loan allows you to use the equity in your departing residence for the downpayment on your new home. With sufficient equity, you can use your current home to purchase your new home. The only cash requirement for a bridge loan is that sufficient funds to cover a portion of the closing costs are placed in escrow by the borrower; usually ranges from 1.5% to 2.5% of the purchase price.
The consumer bridge loan is a balloon loan with a term of either six months or eleven months. Bridge loans have a balloon payment: the full amount of the loan is due at the end of the term. Bridge loans are paid off in one of two ways. If there is sufficient equity in your departing residence when it is sold, the bridge loan will be paid off in full. However, if the equity in the departing residence only pays down a portion of the bridge loan upon sale, the remaining balance must be refinanced into a conventional loan before the bridge loan comes due. These consumer bridge loans are made with the understanding that borrowers will put their departing residence on the market as soon as it is ready for sale.
There are many use cases for a consumer bridge loan. A buyer may need to make a cash-like offer quickly in a tight real estate market and have no time to sell the departing residence to cover the new purchase. Some borrowers can’t qualify for a purchase mortgage before selling their current residence, but they don’t want to be in a position of having no place to live – having sold their current residence before lining up a replacement property. Many bridge loan users are senior borrowers who want to downsize; they often have substantial real estate equity and retirement assets, but they have little income and liquidity and cannot qualify for a conventional loan, and they do not want to sell their existing residence before buying a new one.
Like all residential mortgages, bridge loans have a loan-to-value requirement. However, with the bridge loan the loan-to-value is figured using both properties. Most consumer bridge loans have a maximum loan-to-value of 75%, although for some lenders the maximum loan-to-value is 70%. So, whether or not you can use a bridge loan depends on three things: the value of your current residence, the mortgage balance on your current residence, and the purchase price/value of the home you want to purchase.
Example 1:
Current home value: $1,250,000
Current home mortgage balance: $360,000
New home purchase price $1,540,000
Bridge loan requested: $1,540,000 (100% of purchase price)
To figure loan-to-value we need to combine the values and the loan amounts
Values: $1,250,000+$1,540,000 = $2,790,000
Loans: $360,000 + $1,540,000 = $1,900,000
Loan-to-Value: $1,900,000/$2,790,000 = 68%
This works! This loan amount falls within the LTV parameters
Example 2:
Current home value: $780,000
Current home mortgage balance: $410,000
New home purchase price $1,000,000
Bridge loan requested: $1,000,000 (100% of purchase price)
To figure loan-to-value we need to combine the values and the loan amounts
Values: $1,000,000+$780,000 = $1,780,000
Loans: $410,000 + $1,000,000 = $1,410,000
Loan-to-Value: $1,410,000/$1,780,000 = 79%
Whoops! At 79%, this loan-to-value ratio is too high.
75% of the combined values of $1,780,000 is $1,335,000, therefore the combined loan amounts cannot exceed $1,335,000. The existing mortgage is $410,000; if we subtract that loan amount from the maximum allowable loan amount of $1,335,000 we get $925,000. This is the maximum bridge loan that our borrower would qualify for. Since the purchase price is $1,000,000 the borrower would have to come in with a $75,000 down payment to cover the difference between the maximum loan amount and the purchase price (and don’t forget closing costs!)
All consumer loans except for the bridge loan have an ability-to-repay requirement. This means that there is no income qualifying for a consumer bridge loan, the assumption being that the equity in the departing residence obviates the need for an income requirement. However, and this is important, if the bridge loan will not be paid off entirely by the sale of the departing residence the lender will want to confirm, by looking at your income and assets and credit, that you will be able to qualify for a conventional loan to pay off whatever balance is left on the bridge loan after your departing residence is sold.
Bridge loan lenders are generally make-sense lenders. Credit score guidelines for most bridge lenders are less stringent than the guidelines of conventional lenders.
Most consumer bridge loans will be fully approved in 24 hours, so rather than make your offer with only a ‘subject to’ pre-approval letter, your real estate agent will be able to present a much stronger final commitment letter to submit with your offer so that you can make a cash-like offer with no loan or appraisal contingency and a fast close, usually 17 to 21 days. On a “hot” house this can help you compete with cash offers. If the house you want to buy is not in a competitive bidding situation then the bridge loan, because it lets you make such a clean offer, may help in negotiating a better price.
Bridge loans are expensive. The total cost for the loan including origination fees and interest usually runs between 2% and 3% of the loan amount. You should only use the bridge loan if it makes sense financially. And, it is important to remember that it isn’t just the bridge loan cost that is important, it is also the bridge loan’s value.
Here are some scenarios where the consumer bridge loan might be valuable:
If you don’t want to be in a position where you have listed your old home, but you haven’t yet found a new one. If you can’t find and close on a new home before your old one sells, you may have the hassle and expense of having to rent, store some of your possessions, and move twice.
If the bridge loan is the only way to get the house you want, and the cost is worth it. For example, you are driving around on a Sunday and you happen upon your dream house. Offers are due Tuesday, and there will be many so your offer has to be non-contingent with a very short close. You think you can get it for $1,500,000 and the total cost of the bridge loan will be $40,000. Simple question – is the new house worth $1,540,000 to you? If the answer is yes, you use the bridge loan, and if the answer is no, you pass.
If you have been in your house for a very long time. Your house needs to be emptied, staged, and tarted up a bit – paint, floors, landscaping – before you put it on the market to maximize its value. If you use the bridge loan to buy and move before you put your house on the market, the cost will be, say, $32,000 but your agent believes the house will be worth at least $50,000 more once it is emptied and cleaned up. The bridge loan makes sense – it pays for itself and saves you a lot of hassle.
Bridge loan interest rates are usually 2% to 4% higher than the interest rates on conventional mortgages. Although this is definitely something to consider, because of the short time that most borrowers have the bridge loan the origination fees are usually a more important cost than the high interest rate.
There are often ways for you to accomplish your goals without having the expense of the bridge loan. I have over 30 years of mortgage experience, and if you call me I can often point you to a bank or mortgage broker with a less expensive conventional loan option that will work in your situation.
Please contact me to find out the current fees and interest rate for your scenario.
Consumer bridge loans are short-term loans that have a balloon payment, generally due, depending on the program, in either 11 months or in 6 months. Most bridge loans pay off in less than 4 months when the departing residence sells.
These loans have no prepayment penalty. Some bridge loans have paid off in less than 2 weeks! No matter how quickly the bridge loan pays off, partially or completely, the borrower only pays interest for the time they have the loan.
In most instances the bridge loan does not require a full appraisal on either the departing residence or on the home being purchased.
If you only need money for the down payment on a new home, and a home equity line of credit is not an option, it may be possible to use a relatively small bridge loan as a second mortgage to quickly tap your home equity for a new purchase.
You will have to enroll in a HUD-approved counseling class that costs between $125 and $200; the class can be done over the phone and usually takes 30 to 45 minutes.
The combination of the very short term of the consumer bridge loan – paying off often in 1 to 3 months – combined with the lack of a prepayment penalty means these loans cannot be securitized like all other consumer mortgage loans and so there are currently no conventional, institutional lenders making consumer bridge loans.
Because of the high interest rate and short tem, you want to be in and out of the bridge loan as expeditiously as possible. It is important to be realistic about the market value of your departing residence, and you need to be willing to let the market determine the selling price – even if that price is lower than you hoped. It is also possible that the housing market could weaken after you have gotten the bridge loan, and before you have sold your departing residence, giving you less money to pay down the bridge loan balance. Interest rates may increase between the time you buy your new house and the old house sells, making refinancing a portion of the bridge loan balance, if necessary, more expensive than you had planned.
Still have questions?
If you have questions contact me directly, or learn more about how we can work together.
Richard was instrumental in helping me purchase a house. He also came with me to do the signing at the close of the sale. I cant say enough about how passionate and experienced Richard is in his field.