by Harold J. Copher
Here’s a situation REALTORS and loan originators are frequently presented with. “I need to get the down payment from equity in our current home before my home actually sells. That would make the transition much easier. Can we get a bridge loan?” These clients have identified the new home and would prefer to negotiate a contract before being obligated to do the same with their current home.
A bridge loan is defined as “a temporary short-term loan collateralized by the home being sold, and then paid off when the home actually sells.” It is designed to accommodate the needs of sellers and buyers in short-term transition. For most, this is not a realistic option due to Texas law and being able to qualify for the loan payments.
Lenders are restricted by state law when it comes to the conversion of equity in a primary residence for use as down payment on a new home. Bridge loans are home equity loans, and as such must conform to the restrictions imposed by the Texas (A6) Home Equity Laws.
In 1997, the Texas Legislature passed and voters approved a constitutional amendment permitting home equity lending. Any mortgage loan with net proceeds paid directly to the borrower (homeowner) and secured by a lien on the borrower’s primary residence is considered a home equity loan. Prior to the 1998 implementation of this 1997 legislation, a Texas homeowner did not have access to a mortgage loan on their primary residence in excess of the amount required to pay off any existing mortgage lien.
One of the key provisions of the Texas (A6) Home Equity Law is the restriction prohibiting loan proceeds in excess of 80 percent of the market-value of the home. Therein lies the rub. The only equity funds available to homeowner clients are roughly the difference between their current mortgage balance and 80 percent of the market value of the home. Most people need access to all of the equity in the home they are selling to consummate the purchase of the new home.
If a bridge loan is a type of home equity loan, are other home equity loan offerings potential sources for funds to be used as down payment? Yes and no. Remember, with most Texas Home Equity Loan programs, the homestead cannot be listed on the market for sale. That can pose a problem if the client has already listed the house, their intent is to list the house fairly quickly, or they are considering falsely representing the loan application with respect to the intended use of the proceeds. A bridge loan is designed around the premise that the house will be listed and sold.
Residential mortgage loans generally originate from one of three channels, (1) depository bank, (2) mortgage bank, or (3) or mortgage broker. Of these three entities, a depository bank is the most likely source for a bridge loan. Mortgage banks do not typically offer in-house short-term financing options. A broker channel may be an option, but that loan would likely end up being brokered through a depository bank.
Another potential encumbrance is qualifying. If the client has not closed on the sale of their current home; the current mortgage, new mortgage and/or the bridge loan payment will be included in their debt-to-income (DTI) ratio when qualifying for the purchase mortgage.
Our clients may start by asking about a bridge loan, but most will typically end up with a contingency offer on the new home, complete the sale of their existing home before closing the new home purchase, or leveraging the purchase of the new home with a smaller down payment. They can then pay down the new principal balance when their home sells.
With the last scenario, many homeowners do not realize that most mortgage servicers will permit a one-time recast of the loan balance and monthly payment if the reduction is in excess of 10 percent of the principal balance. A recast refers to retaining the remaining term of the loan and reducing the monthly principle and interest (P&I) payment to match the new principal balance. A typical principal reduction leaves the same monthly P&I payment and reduces the term to match the new principal balance.