What Are Bridge Loans and How Can They Help You?

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Bridge loans provide short-term backing for personal or commercial investments until the borrower can secure permanent funds. In the case of residential bridge loans, homeowners may need to put a down payment on a new home before they have the funds from the sale of their current home. The bridge loan is one of the options for linking this gap. Bridge loans are backed by some form of collateral, such as home equity or, in the case of a commercial loan, an enterprise asset. Due to the high risk and short-term timeline, bridge loan interest rates tend to be higher than other solutions. Bridge loan interest rates are based on debt-to-income ratio, verified income, credit scores, and an appraisal of the loan length.

How a Bridge Loan Works

Perhaps a couple is selling their old home and hoping to buy a new one quickly. The sale of their current home may occur after they find their new dream house. In order to cover the down payment and related closing costs, a bridge loan fulfills their cash needs until the funds from the sale of the old home come through. Companies may also use bridge loans to invest in business expansion or construction projects. These short-term loans are ideal for individuals or companies looking to take advantage of a hot housing market or a time when building materials are at a low price point.

For this reason, bridge loans are designed to last between six months to three years, though they are often repaid in under a year. Banks commonly require a few stipulations to qualify for a bridge loan, such as owning at least 20 percent of the equity of your current home. The maximum amount of a bridge loan is typically 80 percent of the value of your current and new home combined.

When Bridge Loans Help

There are plenty of scenarios when you may need to move homes more quickly than the market allows. For example, perhaps you get a new job in a city across the country and you don’t have the time to wait for your current house to sell. This is where the benefits of bridge loans can really shine. The short-term loan allows you to close on the new house with available funds before solely focusing on selling your old house to pay off the bridge loan. Having the cash on hand also helps you avoid having to make a contingent offer on a home when you’re up against a competitive market.

Business bridge loans are most commonly used for commercial real estate or to cover operating capital. Companies may benefit from a bridge loan if they need immediate funding before a more long-term loan solution comes through. Bridge loans rarely have prepayment penalties like commercial mortgage loans, so companies can pay them off the moment funding with a lower interest rate is secured.

One of the most important reasons bridge loans work is their timing. Be sure to read the specific repayment stipulations of your bridge loan to confirm it lines up with your fund availability.

Benefits and Drawbacks of Bridge Loans

Bridge loans quite literally bridge the gap between a personal or business venture and available funds. If you need the money from the sale of your current home to make an offer on a new home, the bridge loan amount strengthens your offer. As mentioned earlier, a seller may not accept a contingent offer in a competitive market. You can also take out a bridge loan after your current home is on the market, which is not a feature of the more traditional home equity credit.

The timing for paying down the amount is another benefit of a bridge loan. Many lenders will not require payments for the first several months or until your first home is sold, allowing home buyers to use the bridge loan cash to settle into their new house, cover closing costs, and iron out their plan for paying back the amount.

Bridge loans are not right for everyone, however. They are often more costly than home equity loans, requiring higher administration and appraisal fees as well as higher interest rates. Borrowers also must have impeccable credit and steady income to qualify for bridge loans. In the case of a residential bridge loan, for example, the borrower must qualify to pay two mortgages simultaneously. There is also the risk that your home will not sell as quickly as hoped, in which case you could end up essentially paying two mortgages at the same time.

Consider Your Options

Bridge loans may be ideal for those looking for short-term assistance with a clear path for paying off the loan quickly, but it’s important to consider all your options. 

Home equity loans and home equity lines of credit (HELOCs), provide two options for borrowing against the equity of your existing home and often, other assets like your 401K. Though both have a set term for repayment, borrowers often have longer access to the money and a lower interest rate than a bridge loan. In other scenarios, homeowners may be looking to avoid costly mortgage insurance that results from low down payments. An 80/10/10, or “piggy-back” loan, acts as an immediate second mortgage for new or moving homeowners. Borrowers put 10 percent down in cash, borrow 80 percent from a traditional mortgage loan and the remaining 10 percent from an 80/10/10 loan.

Bridge loans can be a valuable tool when making strategic financial decisions. Compare all your short and long-term financing options when looking to buy a new home or making the next move in your business. With the guidance of a financial advisor, choose the loan that best fits your financial profile and future plans.

Sources: Chron | Realty Mogul | Investopedia | The Mortgage Reports | Debt.Org

 

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