What is a Bridge Loan?
Anyone who is on the hunt for an immediate cash injection will probably find themselves asking, what is a bridge loan? The term bridge loan refers to a type of short-term financing. Simply put, it’s designed to alleviate financial strain for homeowners who are selling their existing home and buying a new one.
The loan bridges the gap between the time they have the profits from the sale and the down payment for the new property. The key advantage of this funding solution is that it enables you to put down a deposit on the new house and take out a mortgage. The main disadvantage is the cost, which comes in the form of high-interest rates.
What Is a Bridge Loan in Real Estate?
Bridge loans go by several names. Lenders refer to them as gap financing, swing loans, home bridge financing, or even a bridging loan. But, essentially, they are all referring to the same thing: a type of short-term workaround that allows you to borrow money for up to a year.
In most cases, people use bridge loans when buying property. If they haven’t yet sold their old property, they apply for a loan to provide them with the temporary financing to buy a new one. This extra capital allows them to move into the home they want without having to wait for buyers on their old one.
It’s not the most popular option in today’s market, but it’s gaining traction.
Bridge loans aren’t just a tool for solving buyer impatience, either. There are significant advantages to getting a property quickly. For instance, people moving for work often need to move into new accommodation immediately. They can’t afford to wait six months for a transaction to go through.
Bridge loans are also helpful in hot housing markets. Buyers are able to snap up the properties that they want fast with cash and don’t have to wait for their existing homes to sell.
Businesses can also apply for a commercial bridge loan when they need quick financial support to temporarily cover operating costs and short-term expenses. The loans tie them over until customers pay up.
Bridge Loan vs. Construction Loan
In the world of real estate, there are many loan options. But a lot of the industry’s private and commercial investors typically handle bridge and construction loans.
Both of these loans are a type of short-term financing. But unlike bridge loans, construction loans are used to finance the construction of a property from start to finish. These loans can cover everything from buying the land to labor and material costs.
How Bridge Loans Work
There are two primary reasons why regular homeowners take out bridge loans:
- To finance the deposit on the new house they want
- To close on a new home sale without having to wait for the sale of their existing home to be finalized
If homeowners want to fund a deposit and get the mortgage, they need a quick cash injection. Thus, the purpose of the bridge loan is to finance the gap between the money that homeowners have and what they need.
Here’s an example of a bridge loan:
Suppose you want to buy a property for $300,000, and your existing home is worth $200,000. The deposit on the new property is $60,000 – 20% of the overall price.
If you sell your old home, you will have $200,000 in cash. You can then use this to fund the $60,000 deposit, with $140,000 left over. However, if you don’t sell your old property, you still have to pay the $60,000 to get access to the new mortgage.
That’s where bridge loans come in. They provide the money you need for the deposit upfront so that you can secure a mortgage and pay the seller in full.
However, there are a few drawbacks, including high-interest rates. Banks may give you the money you need to get your new home, but a short-term bridge loan often comes with a hefty price tag.
Also, there is always a risk that you may not be able to sell your home in such a short period of time, which could make it considerably harder to cover your debt.
What Is a Bridge Loan When Buying a House?
Bridge loans typically run for six months to a year. Depending on your circumstances, lenders may be flexible, particularly during complex property transactions that require substantial legal paperwork.
To reduce risk, banks secure bridge loans on your current income. If you fail to repay, lenders can apply for wage garnishment, allowing them to take any money you owe from your bank account.
What Is a Bridge Loan Mortgage?
Most homeowners get a real estate bridge loan from the bank that agrees to finance their mortgage. They are a temporary solution to your financing needs before you sell your house. Lenders charge higher rates on these loans because of the risk that your sale will fall through or that you fail to raise sufficient capital.
Applying for bridging finance works similarly to a conventional mortgage loan. Loan officers will consider multiple factors, including your credit score, credit history, and debt-to-income ratio.
In most cases, your maximum loan-to-value or LTV ratio will be 80%. This means that you’ll need to meet 20% of the equity value of any house you want to buy before you can borrow the remaining balance.
How Much Do Bridge Loans Cost?
So, what exactly is a bridge loan going to cost you? As mentioned above, bridge loans are typically more expensive than conventional mortgages because of the increased risk involved.
Your bridge loan rates depend on your credit score. The prime rate reserved for those with the highest incomes and best credit histories is currently 3.25%. Those with lower credit scores can pay between 8.5% and 10.5%.
As with a mortgage, you must also pay various closing costs when taking out bridging finance. These include the appraisal fee (which determines how much your property is worth), an administration fee (to pay for the labor involved in processing the loan), escrow fee, notary fee, and title policy costs.
Most homeowners who take out bridging real estate finance must pay between 1.5% and 3% of the loan value in various fees.
The Benefits of Bridge Loans
The benefits of bridge loans include:
- The ability to buy a new home without first selling your current one
- The option to make interest-only payments for the duration of the loan
- The ability to avoid monthly payments entirely for the first few months of the loan (available through certain lenders)
- The ability to make an offer on a property
- Access to instant capital for quick transactions and time-sensitive sales
The Disadvantages of Bridge Loans
The disadvantages of bridge loans are:
- The maintenance costs associated with owning two homes at the same time
- High-interest rates
- The cost of various fees associated with taking out the loan
- The risk of foreclosure by the lender if you fail to sell your original home within a specified period
- The need to obtain a mortgage first before you can secure a bridge loan
If you are in the market for a bridge loan, always go to a reputable lender. Many firms promise quick finance, but there is usually a cost, such as high fees, interest rates, and poor customer service. Always consider these factors when weighing up bridge loans vs. traditional loans.
Are There Any Alternatives to Bridge Loans?
You don’t always have to take out a bridge loan for home purchase if you haven’t sold your old one yet. There are other options available that you might want to consider.
An 80-10-10 loan is a type of mortgage product that allows you to buy a new home without having to stump up the full 20% deposit. Think of it as taking out two mortgages. You put down a 10% deposit and then take out the first mortgage on 80% of the property value (as usual) and a second mortgage on the remaining 10%. Then, when you sell your current house, you pay off the 10% part.
Home Equity Loan
Another option is to borrow against the equity of your home. The amount is based on the difference between your home’s market value and the mortgage balance due.
Most home equity loans are long-term because banks can secure them against your property. This means that you don’t have to pay them off rapidly, and rates tend to be low.
Bridge Loan Vs HELOC
HELOC stands for home equity line of credit and is similar to a home equity loan. However, this option allows you to take out a line of credit against your property, not a loan. Unlike bridge loans, HELOCs are typically used to fund home improvements.
To apply, you’ll need a reasonable income, good credit, and a responsible payment history. You’ll also need to prove that you have a low debt-to-income ratio.
We’ve started this post by answering a basic question: what is a bridge loan? Our guide explains that these loans can be helpful for some homeowners in specific circumstances, particularly when they require quick access to capital. A bridge loan for business has a similar function. Of course, there are a number of alternatives, including 80-10-10 and equity loans.
How do you qualify for a bridge loan?
To qualify for a bridge loan, you’ll need to prove that you have at least 20% equity in your current property and that you have the necessary income to make payments. Lenders may also consider your credit score and how you have handled debt in the past.
Is a bridge loan a bad idea?
Not necessarily. If you are confident that your existing home will sell within the specified period, then it can be a great way to snap up the new property you want quickly. However, if you fail to sell your old home, you may face foreclosure.
What is a bridge loan example?
Homeowners may take out bridge loans when they want to buy a property in a hot housing market. Getting the cash they need quickly allows them to close the deal.
What does a bridge loan cost?
Bridge loan costs depend on your creditworthiness. Those with good scores may pay 3.5% APR, while those with lower scores can expect to pay up to 10.5% APR. Total closing costs can range between 1.5% and 3% of the loan value.
I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.
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