A bridge loan is a type of financing that enables homebuyers to borrow money against their existing home’s value to fund the down payment for their new home. This type of loan benefits those who want to purchase a new home before selling their current one. Businesses can also use bridge loans to cover their operating costs while waiting for long-term funding.
To secure a bridge loan for real estate purposes, the borrower must use their current home or other assets as collateral, provided they have at least 20% equity in that home. However, borrowers should be aware that bridge loans typically come with high-interest rates and short repayment periods, usually lasting between six months and a year. Therefore, bridge loans are more suitable for borrowers who anticipate that their current home will sell quickly.
Here we will explain everything you need to know about bridging loans so that you can find whether it is the right funding option for you or not.
What Is A Bridging Loan?
Bridge loans, also known as bridge financing, bridging loans, interim financing, gap financing, or swing loans, are a type of short-term financing that enables individuals and businesses to borrow money for up to one year. To secure the loan, borrowers must provide collateral, such as their home or other assets. However, bridge loans typically have higher interest rates ranging from 8.5% to 10.5% compared to long-term financing options.
One of the main advantages of regulated bridge loans is that the application and underwriting process is usually faster than traditional loans. If you qualify for a mortgage to purchase a new home, you may also qualify for a bridge loan as long as you have sufficient equity in your first home. For this reason, bridge loans are often an attractive option for homeowners needing immediate funds to purchase a new property before selling their home.
When Can You Use A Bridging Loan?
The primary use of bridge loans is to facilitate the purchase of a new home by homeowners who have not yet sold their current property; such loans are usually known as residential bridging loans. Alternatively, a homeowner can use a bridge loan as a second mortgage to cover the down payment for their new house.
A bridge loan is a suitable option if you:
- Have identified a new property to purchase in a seller’s market where homes sell quickly.
- Want to buy a property, but the seller will not accept an offer contingent on selling your current home?
- You cannot afford the new property’s down payment without first selling your current home.
- Want to close on a new home before selling your current property?
- Are you not scheduled to close the sale of your current home before closing on the new house?
Aside from real estate purchases by homeowners, bridge loans can also be utilized by businesses to seize immediate real estate opportunities or to fund short-term expenses. These loans are usually offered by hard money lenders who provide loans using the borrower’s property as collateral and online alternative lenders. However, when obtaining bridge loans, businesses should expect higher interest rates than other types of business loans.
What Is The Cost Of Bridging Finance?
Bridge loans provide temporary financing for individuals who wish to purchase a new property but have not yet sold their current real estate. However, this financing typically incurs higher costs than a traditional mortgage. The borrower’s creditworthiness and loan size influences the interest rate for bridge loans and typically range from 3.25% (current prime rate) to 8.5% or 10.5%. For business bridge loans, the interest rates are even higher, ranging from 15% to 24%. In addition to the interest payment, borrowers must also pay closing costs and other legal and administrative fees.
Pros Of Bridging Loans
- Borrowers can get quick access to funds
- It provides flexibility while searching for real estate
- It offers faster application, underwriting, and funding than traditional loans.
Cons Of Bridging Loans
- Bridge loans often come with higher interest rates
- Bridge loans are secured debts, which means borrowers must pledge their homes or other assets as collateral.
- Borrowers must pay debt service on the bridge loan on top of their current mortgage.
Bridging Loans Alternative
Bridge loans can be a useful tool when in need of immediate funds but lacking access to long-term financing solutions. However, it’s important to weigh the risks before committing to this option, such as the possibility of losing your first home, the short-term nature of the loan, which usually lasts for up to a year, and the high-interest rates associated with it. Before taking out a bridge loan, consider exploring alternative financing options.
Home Equity Loan
A home equity loan is a lump sum payment borrowed against home equity, with interest rates similar to HELOCs. It’s suitable for homeowners with a fixed amount for their new home’s down payment.
Business Line Of Credit
Businesses can use a revolving loan called a line of credit to cover short-term expenses, which is different from a lump sum bridge loan. With a line of credit, borrowers only pay interest on the amount they draw, and loan terms typically range from a few months to 10 years. Interest rates differ by lender and can be as low as 7% from traditional banks.
Home Equity Line Of Credit
HELOCs are a practical option for covering down payments on new homes. They allow homeowners to access their home equity on a revolving basis with lower interest rates and longer repayment periods compared to bridge loans. Borrowers can draw against the HELOC as needed and repay the debt when they sell their first home, reducing the risk of default and losing their home.
Conclusion
In conclusion, bridging loans can be a useful option for individuals and businesses needing short-term funding for real estate purchases or short-term expenses. However, borrowers should be aware of the high-interest rates and the risk of losing their collateral and explore alternative financing options before committing to a bridge loan. It is essential to weigh the pros and cons carefully and make an informed decision based on individual financial situations and goals.