The purpose of a bridge loan is to provide funds for the purchase of a new home when the existing home is sold but settlement will not occur until after the new home is purchased. A bridge loan allows you to apply the net equity in the existing home as a down payment for the new home before the equity is realized. The bridge financing can also alleviate some of the timing pressure to move immediately from the old house to the new house on the closing date. The bridge loan allows you to move into the new home over several days.
How does a bridge loan work?
Collateral/Equity - The current residence is utilized as collateral for the bridge loan, and in some cases, a lien is also placed on the new home. The term of the bridge loan can vary from one week to twelve months.
Principal and accrued interest on the bridge loan is paid in full when the current residence is sold and settlement occurs. You have the option to make monthly interest payments during the term of the loan, or at maturity in the case of a short-term loan (when the home is sold).
Fully executed copies of the sales agreements are provided to your financial institution to verify that the existing home settlement will occur. It is important to review the sales contract to determine that the contract for the sale of the existing home is contingency-free.
Payments - During the term of the bridge loan, you are typically responsible for paying the following:
You must be able to debt service the loan(s) through your personal cash flow and/or liquidation of other assets. Your monthly debt service to gross monthly income ratio (including all of the loan payments) should not exceed 36%. Exceptions can be made when the loan-to-value (LTV) is low and/or if there are significant liquid assets that can be sold to satisfy the debt service. The LTV is the ratio of the total loans against the property compared to the appraised value. A lower LTV allows for a reduction in sales price if something should go awry with the sale of the old residence.
The financial service provider typically verifies the value of the current home through a residential valuation or drive-by appraisal. If the bridge loan is greater then $100,000, and the term of the loan is greater than an estimated three months, a full Fannie Mae approved appraisal must be done.
Each situation is different. The amount and term of loan, LTV, debt service coverage, and other factors all figure into the structure of a bridge loan. It's important to find a customized bridge loan that satisfies your unique situation.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.