(Updated November 2014)
When the air is frosty and the cold winds blow, most people grab the nearest blanket and cuddle up. It provides comfort when life becomes anything but. In much the same manner, a blanket loan can make mortgage financing during a transitional phase an easier process.
A blanket loan is a single mortgage that "covers," or is secured by, more than one parcel of property. They're most commonly used by investors or commercial land developers, but in some cases they may also be used in residential transactions as a bridge between the old and new mortgage. In that situation, the blanket loan covers both homes until the old property can be sold.
The most important characteristic of this type of loan is a "release clause," which allows the borrower to sell off one or more of the securing parcels without having to refinance. This differs from a traditional mortgage, which typically requires the borrower to pay the loan balance in full if the securing property is sold.
On commercial projects (most common use)
Residential land developers use blanket loans regularly to fund the purchase of large land tracts. At funding, the loan is secured by 100 percent of the purchased land. Over time, the developer subdivides the property and sells it off in pieces. Upon the sale of each piece, that portion of the security is released, and the developer uses the proceeds to pay off a portion of the loan.
Consider the construction of a subdivision. A developer might use a blanket loan to assemble several tracts of land, then subdivide it into individual lots for home construction. As each home is completed and sold, that property is separated out from the blanket loan without disrupting the financing arrangements for the rest of the development.
Bridging the gap
Individual buyers sometimes use blanket loans to ease the transition between the sale of an existing home and the purchase or construction of a new one. For most homeowners, this type of financing is a streamlined alternative to such options as carrying two separate mortgages, taking out an expensive short-term loan, or selling early and living in a rental.
This is done when the buyer still has a mortgage on their old property but needs to take out a new one on the new property. Often, such transactions are covered by a contingency clause - a clause stating the new home's purchase and mortgage will not be closed until the hold home is sold.
A contingency clause frees the buyer of financial responsibility for the old home before actually buying the new one. However, it means the borrower has to sell the home before the contingency clause expires - which can pressure the borrower into selling their old home quickly, perhaps on less desirable terms.
A blanket loan avoids this problem by giving the borrower more time to sell their old home. In some cases they may be structured as a interest-only loan for up to 12 months before full amortization kicks in, which gives you a reasonable amount of time to sell your old home at a fair price and lessens your total mortgage burden as well.
The pros and cons
The biggest downside of a blanket loan for a residential home purchase is that they're, quite frankly, pretty hard to find in the post-crash era. While some lenders are offering them once again, you may have to look pretty hard to find one. But as time goes on and lending conditions return more to normal, look for more lenders to offer them.
Efficiency and flexibility are the biggest advantages. An individual using a blanket loan would have only one mortgage payment instead of two. A developer can proceed with selling off portions of its investment without continually refinancing the associated debt. In the event of a default, the bank or financial institution can take control of all of the property securing the loan.
A blanket loan also eliminates the need to do any refinancing when the old home is sold. At that point, when the portion covering the old home is paid off, the blanket loan simply becomes a standard mortgage covering the new home.
On the downside, you still need to be able to qualify for a single mortgage covering the payments on both your old home and new one, which may be a stretch for some borrowers. Of course, if you can arrange it as an interest-only loan until the old property is sold, that gives you some payment flexibility.
When financing multiple properties creates discomfort, you might find that reaching for a blanket loan will give you warm and fuzzy peace of mind.