What is a Bridge Loan and How Does it Work?

Do you need a short-term loan to purchase another home, business, or for immediate funds? Have you heard of a bridge loan?

Bridge loans are a short-term financing option until more permanent funding is available. For example, if you currently own a home but want to purchase another home before your current home sells, you may want to consider a bridge loan.

If you’re wondering what is a bridge loan, you have come to the right place. This article will break down bridge loans.

What Is a Bridge Loan?

Bridge loans are short-term loans, typically 6-12 months. They are also referred to as “interest only” loans. These loans help bridge the gap between the time something is purchased until the funding is available.

These loans also do not have exit penalties. You can pay them off as soon as possible.

If you get a bridge loan to purchase a new home before your current home sells, your home is used for collateral. You need to have at least 20 percent equity in your first mortgage.

Different Types of Bridge Loans

There are different types of bridge loans.

  • Personal property to buy another home
  • Office to transition to another office space
  • Multifamily to renovate units for additional rent
  • Industrial to renovate commercial properties
  • Retail to get a new space quickly
  • Hospitality to secure funding

These loans are quicker than traditional funding. They can also be harder to get than traditional loans.

How Do Bridge Loans Work?

Unlike regular mortgages or loans, several lenders do not have guidelines such as credit score minimums or debt-to-income ratios. They examine it from an individual underwriting approach.

A bridge loan can be created in various forms. Generally, the money is used to pay off the existing loan. You may be required to pay monthly on the bridge loan or you can pay upfront interest.

Here’s an example of how it looks. You currently own a $200,000 home and your existing mortgage balance is $100,000. You purchase a $300,000 home.

You take out a $135,000 bridge loan. The first $100,000 pays the lien on your current home. The $5,000 pays for closing costs and fees.

You will then have $30,000 to put toward the down payment on your new home.

When you move, you will start paying your monthly and your bridge loan payment. This could be two payments or one payment. You may be able to add your bridge loan payment to your existing mortgage.

After you sell your other home, you will pay off the bridge loan. You can pocket any additional money you make.

Bridge loans typically have higher interest rates because they are short-term.

Difference Between Traditional and Bridge Loans

You can get a bridge loan quicker than a traditional loan. Because these loans can be approved quickly, there are higher fees and interest rates. It’s the lender’s way of having you pay for convenience.

The speed of a bridge loan is the biggest selling factor to customers. People know it is short term and will pay it off with lower interest when long-term finance is secure.

Other Reasons to Get a Bridge Loan

There are several reasons you may want a bridge loan. If you are buying your next home at an auction, you need cash for the purchase.

Investors use bridge loans to flip properties. They don’t own the property for a long-time but need funds for renovations.

If you are relocating to another city or country, you can get your down payment to have your home ready when you need to move.

When building a house, you may need cash before it is completed. You will secure your traditional mortgage when your house is completed.

What You Need for a Bridge Loan

In order to qualify for a bridge loan, you should consider:

  • Your credit
  • Finances
  • Real estate market

If you are eligible for a home buyer assistance or down payment program, you will not need a bridge loan. Remember, this is a quick loan, so if you have the money saved, you do not need this loan.

Benefits of a Bridge Loan

Here are some benefits of bridge loans:

  • Put your home on the market
  • Buy a house when you find the right house
  • Most loans do not have monthly payments for a few months

You need to be able to make two mortgage payments comfortably even if it is only for a few months. There is no way to guarantee how long you will have these two payments.

Bridge loans make you more competitive in the real estate market because you don’t have to make a “contingent” offer.

Drawbacks of a Bridge Loan

There are some things you should consider about bridge loans. They are:

  • More expensive
  • Harder to get
  • Another payment

If you are relying on your home to sell to pay this loan, you should look at the market. Is it slow? There is no guarantee how quickly your current home will sell.

You are also relying on the people buying your current home. You are also dependent on the sale going through without any complications.

You may want to consider doing a home inspection on your current home before getting a bridge loan to prevent any surprises.

How to Find a Bridge Loan

Finding a bridge loan is much different than shopping for a traditional loan or mortgage. There are no guidelines for short-term loans like traditional loans. You may qualify with one lender and not another.

A traditional loan has guidelines that are universal to most lenders. Short-term financing is up to the lender. The lender chooses the best underwriting practice for their institution.

You should contact several lenders and brokers to find out their requirements. They will most likely be different.

You should then compare the requirements of all the lenders. You can see if you meet these guidelines.

Find the best lender that has the terms that meet your needs.

For more info on applying for a bridge loan, talk to an expert to see what short-term financing is right for you.

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