Bridge loans let homebuyers take out a loan against their current home to make the down payment on their new home. A bridge loan may be a good option for you if you want to purchase a new home before your current home has sold. This form of financing may also be helpful to businesses that need to cover operating expenses while awaiting long-term funding.
When used for real estate, a bridge loan requires a borrower to pledge their current home or other assets as collateral to secure the debt—plus, the borrower must have at least 20% equity in that home. Bridge loans also tend to have high-interest rates and only last for between six months and a year, so they’re best for borrowers who expect their current home to sell quickly.
What is a Bridge Loan
A bridge loan is a form of short-term financing that gives individuals and businesses the flexibility to borrow money for up to a year and is secured by collateral such as the borrower’s home or other assets. Bridge loans typically have interest rates between 8.5% and 10.5%, making them more expensive than traditional, long-term financing options.
Bridge loans also offer flexibility. Unlike traditional mortgages, they have shorter terms ranging from a few weeks to a year. This means you can repay the loan once your existing property is sold. Additionally, bridge loans typically do not require monthly payments, allowing you to focus on your new property without the added burden of multiple mortgage payments.
However, the application and underwriting process for bridge loans is generally faster than for traditional loans. Plus, if you can qualify for a mortgage to purchase a new home, you can probably qualify for a bridge loan—assuming you have the required equity in your first home. This makes bridge loans a popular option for homeowners who want quick access to funds to purchase a new house before they have sold their current property.
How Bridge Lending Works
Often when a homeowner decides to sell their current home and purchase a new one, it can be difficult to first secure a contract to sell the home and then close on a new one within the same period. What’s more, a homeowner may be unable to make a down payment on the second home before receiving money from the sale of their first home. In this case, the homeowner can take out a bridge loan against their current home to cover the down payment on their new home.
In this situation, a homeowner can work with their current mortgage lender to obtain a short, six- to 12-month loan to “bridge the gap” between the new purchase and the sale of their old home. Not all traditional mortgage lenders make bridge loans, but they’re more commonly offered by online lenders. Although bridge loans are secured by the borrower’s home, they often have higher interest rates than other financing options—like home equity lines of credit—because of the short loan term.
Once the borrower’s first home is sold, they can use the proceeds to pay off the bridge loan and they will be left with just the mortgage on their new property. However, if the borrower’s home does not sell within the brief loan term, they will be responsible for making payments on their first mortgage, the mortgage on their new home and the bridge loan. This makes bridge loans a risky option for homeowners who aren’t likely to sell their home in a very short amount of time.
When to Use a Bridge Loan
Bridge loans are most often used when a homeowner wants to buy a new house before selling their current property. A borrower can use a portion of their bridge loan to pay off their current mortgage while using the rest as a down payment on a new home. Likewise, a homeowner can use a bridge loan as a second mortgage that covers the down payment for their new house.
Final Thoughts
While bridge loans can be a useful tool in real estate transactions, it is important to consider the associated costs and risks. These loans often come with higher interest rates and fees, so it is crucial to carefully assess your financial situation and calculate the potential costs before proceeding.
In conclusion, if you find yourself in a situation where timing is crucial in your real estate transaction, a bridge loan can be the perfect solution. It allows you to secure financing for your new property while waiting for the sale of your current property. Just remember to weigh the costs and risks before making your decision.
