Most of the time, when upgrading or downsizing homes, you may need to sell your existing home to liquidate funds to purchase your next home. Since you cannot sell your current home without having a new home to move into, bridge loans and home equity lines of credit (HELOC) are two viable options in this situation.
What Is a Bridge Loan?
A bridge loan is a hard money short-term loan that will cover the financing of your new home while you wait for your existing home to sell. Typically, these loans are one year or less and require collateral, which can be your current property in the form of home equity or any other assets you own. Once you sell your current home, you can repay the bridge loan out of the proceeds from the sale.
Bridge Loan Advantages
As with any financial venture, you should weigh the pros and cons before you sign up for a bridge loan. Advantages include:
- No income verification needed. Typically for owner-occupied property, federal regulations require that lenders verify the borrower’s income, and the debt-to-income ratio remains within prescribed minimums. This verification requirement is commonly called the ability-to-repay rule (ATR). Since bridge loans are short-term loans of 12 months or less, the federal government has exempted them from the ability-to-repay requirements because the sale of the current home repays the loan in short order. This exemption is especially advantageous for retirees or anyone on a set income.
- Quickly approved and funded. One of the best advantages of a hard money bridge loan is that it can be approved quickly. Owner-occupied bridge loans only take a couple of weeks, while non-occupied investment property takes only a few days.
- Secured by property on the market. Bridge loans exist to help bridge the gap between buying a new house and selling the current home, so there won’t be an issue if your home is on the market, as that is the point.
- Flexible. Lenders who offer hard money bridge loans are not subject to the same strict criteria that banks have to follow for standard loans. You can offer the current home, the home you are purchasing, or both as collateral for your bridge loan. If there’s equity in either property, you can use it.
- Bad credit, not a dealbreaker. Banks and credit unions that offer traditional loans focus on credit scores and little else. Conversely, a bridge loan lender will look at the whole picture of a borrower’s credit report while focusing primarily on the borrower’s equity in the current property and the value of the new property. As long as the equity is there, you can get a bridge loan regardless of your credit score.
Bridge Loan Disadvantages
A bridge loan does have its disadvantages as well, including:
- Higher interest rates and fees. Due to higher perceived risk and the short-term nature of bridge loans, the fees associated with procuring the loan and the interest rate itself both tend to be significantly higher than traditional loans.
- Short-term use only. To be exempt from the Ability to Repay requirement, the term of a bridge loan must be 12 months or less. Usually, this isn’t an issue as 12 months is typically ample time to buy a new home and sell your current home. However, if there are any issues or the market is cold, this can be problematic.
- Challenging to obtain from lending institutions. Banks and credit unions tend to focus on long-term loans and are typically not interested in bridge loans or other short-term loans. On the outside chance a borrower can procure a bridge loan from a credit union or bank, it will take much longer to get funded than a hard money lender.
What Is a HELOC?
A HELOC is a credit line, much like a credit card, that you can take out against your home’s equity. Typically, lenders are willing to extend a line of credit up to 80% of the equity in your home. You can use as much or little of this amount as you want and pay it back with interest, much like you would a credit card.
You may wish to consider a HELOC, so it’s important to look at its advantages, such as:
- Lower rates and fees. A bridge loan needs to charge higher interest rates and fees to make a profit in the short term of the loan. Since that isn’t the case with a HELOC as it is a long-term, open-ended line of credit, the interest rate of a HELOC is typically only a point or two higher than a standard mortgage. Another benefit is that often a HELOC is funded with little to no closing costs or origination fees.
- Loan-to-value ratios. Usually, when offering a HELOC, the lender will allow the credit line to be between 70 to 80% of the current market value and the amount remaining on the mortgage.
A HELOC may not always be your best option. Disadvantages of a HELOC include:
- Extended funding and approval times. The approval itself can take a couple of weeks once submitted, and then after approval, it can be up to 30 more days before the HELOC gains funds.
- Requires good credit and proof of income. Banks and credit unions are typically very selective regarding your credit score. There is simply a minimum score, and if you do not meet it, you are out of luck. Also, it would help to have a debt-to-income ratio that the lender finds acceptable. If you have any adverse credit items like foreclosure, bankruptcy, short sales, or loan modifications, the lender may flat out deny your application.
- Not available for homes on the market. Once you list your home for sale, banks and credit unions typically won’t extend a HELOC against it. Listing your home lets the lender know the debt will most likely be paid off in short order, contrary to their interest in making money long term via interest. You can get a HELOC first and then put your home up for sale.
For more information on bridge loans versus HELOCs, reach out to the knowledgeable team at Titan Funding. We can help you decide which option is best for your situation. Reach out to us today at 855-928-0737 or via our convenient and secure online messaging service. Titan Funding offers several financing services, including residential bridge loans, to meet your needs.