Borrowisely!

Bridge Loan

Elena Romanova — Fri, 29 Aug 2008 23:22:26 +0000

Today’s article explains the equity way to close the financial gap between the new and the old homes’ mortgages.

A lot of people count on the money they are going to get from selling their current home to make a proper down payment on their new home and start a new mortgage. Unfortunately, many properties get stubborn at the point and refuse to sell while their owners are gradually getting frustrated at somebody else snatching the perfect home right from in front of their nose.

The frustration can be avoided in several ways, including financial aid from friends and relatives, or retirement accounts. If those fail, a bridge loan can certainly be of help.

A bridge loan is usually provided by the lender of the new home’s mortgage, but its collateral is the old home. Most bridge loans are short term high rate interest-only mortgages. The term is usually as short as 6 months; so if you are not sure that your current home will sell so soon, make sure there is an option in the contract allowing you to extend this period. Any lender will give you a hundred reasons to justify the high rate, but as it is an interest-only (if it is in your particular case) mortgage, the monthly payments do not add up to outrageous totals just because your current home is very likely to get sold well before the amounts involved go out of control.

A secured bridge loan makes it obligatory for you to sign your new home’s mortgage with that same lender, so always look first what the lender has to offer in the field of mortgages you are ultimately targeting on, because that latter one is the deal you’ll have to stick to for years. The conditions have to be favorable.

Bridge mortgages can vary in structure. Some pay off the first mortgage of the old home at the bridge loan’s closing and this amount adds to the sum you borrow to close on your new home. This total becomes the amount of your bridge loan and you pay interest on it until your old home sells and you receive cash to pay the loan off partially or completely. Thus, as you close on your new home, you will have two mortgages: a new first mortgage and the bridge mortgage.

The other way is just to add the new debt to the old one. This way you have three loans to attend to when you close on your new home: your old loan, your new first loan and the bridge loan.

Unsecured bridge loans are as rare as the circumstances which can suggest them. If your credit score is impeccable and you know for sure, i.e. have a binding contract of sale, that your old home will be sold at a certain date, you may try and find a bank that will write an unsecured bridge loan. As the lender is certain of the date and the amount of sale, he may be more willing to avoid putting a lien on that property. First and probably only choice is a bank, which you are already a client of, but even with them you may have to be quite insistent. Banks do not like short-term unsecured deals.

If your old home is not on the market yet, the choice of means is considerably wider. You can put the equity accumulated in your old property to work for you. You can start a HELOC, or a regular equity loan secured by the equity you have in your old home. The closing costs of these solutions are considerably lower than those of, say, a cash-out refinancing, but the rates are higher. A HELOC or some other high rate equity loan will come out overall cheaper if the “bridging” period is short. The longer the “bridging” period is expected to be, the more sense it makes to cash out by refinancing and pay a lower rate for as long as it takes for the house to sell. You can even rent the property out for some time to compensate for your expenses.

What is the minimum down payment required to buy a home?

Elena Romanova — Tue, 12 Aug 2008 22:16:34 +0000

Actually, there is no limit to the size of a down payment. It can even be 0% with certain kinds of mortgages, but you have to be able to qualify for it. Another tricky part here is the Mortgage Insurance. If your down payment is lower than 20% of the purchase price (or the appraised value, whichever the lowest on the day of purchase) of the property, you will be obliged to pay private mortgage insurance (PMI) premiums until the outstanding balance of your mortgage hits the 80% of the purchase price margin. PMI is usually not cheap, so a lot of people prefer alternatives, such as a conventional second mortgage, a piggyback mortgage (80/20) or LPMI. The size of a second mortgage or a piggyback mortgage is determined by how much cash you are ready to put down, the rest can be borrowed.

If, for example, you are planning to put only 5% of the purchase price down, you can either go for a large 95% first mortgage with PMI, or borrow 80% with a first mortgage without PMI and another 15% with either a conventional second mortgage or a piggyback mortgage. The interest rate on the second mortgage will be higher than that on the first one, but still it will very likely result in lower monthly payments than PMI premiums.

There is also a slight issue of tax deductibility involved. While mortgage interest payments are unquestionably tax deductible, PMI premiums are deductible only for mortgage insurance contracts issued from Jan. 1, 2007, through Dec. 31, 2009.

Is there a way to amortize an interest-only mortgage?

Elena Romanova — Thu, 07 Aug 2008 21:44:54 +0000

Normally, your monthly payments do not include anything to be paid towards the principal during the interest-only period of your mortgage. On the one hand, it makes these payments lower; on the other hand, when the interest-only period is over you have to face the debt you borrowed years ago in its full size again, only now you have a shorter period of time to repay it. That is why it is strongly recommended to make voluntary extra payments towards the principal during the interest-only period, if your lender allows you to. If he does, make sure the outstanding balance gets adjusted immediately after an extra payment is made. Sometimes a special arrangement for extra payments during the interest-only period is included into the mortgage contract. If you are only planning to take out an interest-only mortgage and intend to make extra payments, pay special attention to these details in your contract. The problem is that many lenders do not adjust the balance during the interest-only period at all, with or without extra payments, unless stated explicitly otherwise in the contract. If the balance gets adjusted (becomes smaller), the amount paid as interest (percentage of the outstanding balance) becomes smaller, too. This way your monthly interest-only payments become even lower (provided the rate is unchanged or drops). If the first adjustment will take place only after the interest-only period is over, all the monthly payments during the interest-only period remain unaltered. It does not mean that you will eventually pay more as interest, though. Everything will be recalculated, your extra payments, as well as the overpaid interest, will be subtracted from the balance, when the time comes. The tricky part here lies in the investment opportunities available to you at the time of your extra payments. It may so happen that an alternative investment would have brought you a better return, if you had invested into it, rather than the mortgage, whose return you will see only in a few years.

For more on Interest-Only Mortgages read here.

How come I have been paying my mortgage for 2 years, but the balance is actually growing?

Elena Romanova — Tue, 05 Aug 2008 22:28:49 +0000

This very unpleasant situation is called negative amortization. The most likely causes are:
i) You have an adjustable rate mortgage with a payment cap that does not allow you to raise your monthly payment enough to match the new interest rate. As a result, your monthly payment is probably high enough to cover the principal part and some of the interest, but all the underpaid interest is added to the outstanding balance. The situation calls for emergency action!!!
ii) You have an option adjustable rate mortgage and you stick to the minimum payment option, even though the rate has changed. If you have ignored the raised rate for 2 years you are in big trouble, because most option ARMs carry a 7.5% a year minimum payment cap. Under such a limitation it is very problematic to catch up with the new rate and the debt it has already produced. The only way out of this is selecting some other option for your monthly payments immediately; otherwise negative amortization can increase your debt to a virtually unpayable amount.

How come I have been paying my mortgage for 2 years, but the balance is (practically) unchanged?

Elena Romanova — Tue, 05 Aug 2008 22:24:34 +0000

The reasons for that can be:
i) If your have a conventional fixed-rate or adjustable rate mortgage, and it is really as young as 2 years, it is natural for the balance to reduce insignificantly because of the “leveling” of monthly payments. You can find a more detailed explanation in my article about FRMs; but in short, in early years each monthly payment pays mostly towards the interest. Only in later years the monthly proportion of money paid towards the principal increases and then the reduction of the outstanding balance becomes more noticeable. The principal payment is always a remainder - the total monthly payment minus the interest; and if with a FRM everything is pre-calculated and the monthly amount is set, ARM monthly payments change to meet the new rate and serve, first of all, the interest; the principal gets the residual. Generally, this case presents nothing to worry about.
ii) If the balance is totally unchanged, you probably have an interest-only mortgage, i.e. everything you pay every month is paid towards the interest only.The balance will start to reduce only if you make an extra payment or when the interest-only period is over. For more details on Interest-Only mortgages read here.