Many hard money lenders who make primarily business-purpose loans consider consumer bridge loans as a path to diversify their business while still avoiding some of the most restrictive consumer loan protections.
However, many lenders are unclear on what exactly qualifies as a “bridge loan” and which consumer protection laws apply.
Regulation Z provides some special exemptions for “bridge or other temporary loans”, but does not define what a “bridge or other temporary loan” is apart from two examples:
- A loan of 12 months or less to enable a consumer to buy a new home before he or she has sold their existing one, and
- A ground-up construction loan
These two categories shall hereafter be collectively referred to as “bridge loans”. They are the only types of loans which may be relied upon to fit within the bridge loan exemption. For bridge loans in Category 1, it is crucial that you document the intention to make the new home the borrower’s primary residence within 12 months of closing, as well as the intention to sell the existing home.
All bridge loans are exempt from a variety of Regulation Z provisions, including the prohibition on balloon payments, the escrow impound account requirement, the appraisal requirement, and, perhaps most significantly, the ability to repay rule.
However, there are variations in the applicability of the 3-Day Right to Cancel Rule depending on the type of property to be encumbered by the bridge loan. Here, we will examine three scenarios where a homeowner has selected a new home for purchase with the intention of selling an existing home:
Scenario 1 – Lender Executes a Deed of Trust on Existing Home Only
The 3-Day Right to Cancel Rule would apply.
Scenario 2 – Lender Executes a Deed of Trust on Existing Home and a New Home
The 3-Day Right to Cancel Rule would apply.
Scenario 3 – Lender Executes a Deed of Trust on Future Home Only while Borrower Sells Current Home
The 3-Day Right to Cancel Rule does not apply to a loan to acquire or construct a new principal dwelling that is secured by such new dwelling, as it is a “residential mortgage transaction” that is granted an exemption under 1026.23(f)(1). Since the consumer is assumed to not be living in the new dwelling when the loan is made, the rescission protection typically given for an owner-occupied principal dwelling is not applied.
One area of Regulation Z that many bridge loans will still have to contend with is Section 32. Because of their short duration, bridge loans often fall within the definition of a high-cost mortgage in Section 32, which requires brokers to apply HUD counseling and prohibits advance payments, default interest, late fees greater than 4%, and financing soft points and fees, which will have to be paid outside of the loan closing.
A lender must also keep in mind that, like other consumer loans, bridge loans are subject to TRID disclosures and care must be taken from the point of application that all applicable federal and state lending rules are taken into consideration to ensure that compliance issues will not arise down the road.
As you can see from this discussion, the rules surrounding bridge loans on owner-occupied primary residences can be confusing. However, if adequately documented, taking into consideration the rules surrounding bridge loans, these types of loans can be highly profitable.
