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Bridge loans enable homebuyers to borrow money against their existing residence in order to pay for the down payment on a new residence. If you want to buy a new house before your current one sells, a bridge loan might be a good choice for you. Additionally, businesses that need to pay operating costs while awaiting long-term funding may find this type of financing to be beneficial.
A borrower using a bridge loan for real estate must have at least 20% equity in the home they are currently living in as well as be willing to use it as collateral to secure the debt. Bridge loans are best for borrowers who anticipate a quick sale of their current home because they tend to have high interest rates and only last six months to a year.
What Is a Bridge Loan?
With the flexibility to borrow money for up to a year, a bridge loan is a kind of short-term financing that is available to both individuals and businesses. Bridge loans, also known as bridging financing, interim financing, gap financing, and swing loans, are backed by collateral like the borrower’s house 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.
However, compared to conventional loans, the application and underwriting process for bridge loans is typically quicker. In addition, assuming you have the necessary equity in your primary residence, you can probably qualify for a bridge loan if you can qualify for a mortgage to buy a new home. Due to this, bridge loans are a well-liked choice for homeowners who need quick access to money to buy a new home before they sell their current one.
How Bridge Lending Works
It can be challenging to first secure a contract to sell the home and then close on a new one within the same period when a homeowner decides to sell their current one and buy a new one. Additionally, a homeowner might not be able to put money down on a second home until they receive proceeds from the sale of their primary residence. In this situation, the homeowner may be able to obtain a bridge loan against their existing property to pay for the down payment on a new residence.
A homeowner can “bridge the gap” between the purchase of a new home and the sale of their old one by working with their current mortgage lender to obtain a brief, six- to 12-month loan in this circumstance. Bridge loans are not always made by traditional mortgage lenders, but they are more frequently provided by online lenders. Although the borrower’s home serves as security for the loan, due to the short loan term, bridge loans frequently have higher interest rates than other financing options, such as home equity lines of credit.
The borrower can use the proceeds from the sale of their first home to pay off the bridge loan, leaving them with only the mortgage on their new property. However, the borrower will be liable for making payments on their first mortgage, the mortgage on their new home, and the bridge loan if their residence does not sell during the brief loan term. Due to this, homeowners who aren’t planning to sell their house quickly should avoid taking out bridge loans.
When to Use a Bridge Loan
When a homeowner wants to purchase a new home before selling their current property, bridge loans are most frequently used. A borrower may use some of their bridge loan to settle their existing mortgage and the remaining sum as a down payment for a new house. Similar to a second mortgage, a bridge loan can be used by a homeowner to pay for the down payment on a new home.
A bridge loan may be a good fit if you:
Businesses can also use bridge loans to fund short-term expenses or to seize present real estate opportunities. Hard money lenders, who finance loans using your property as collateral, and online alternative lenders are typically where businesses can find these loans. In comparison to other business loan types, these loans have higher interest rates.
Some common uses for business bridge loans include:
If you want to buy a new home or other real estate but haven’t sold your current property, bridge loans are a convenient way to get temporary financing. However, the cost of this financing is typically higher than that of a conventional mortgage. Bridge loan interest rates range from the prime rate—currently 3 percent—but can vary depending on your creditworthiness and the amount of the loan. 25%—to 8. 5% or 10. 5%. Business bridge loans have even higher interest rates, which typically range from 15% to 24%.
Borrowers shall pay closing costs, additional legal and administrative costs, and interest on the Bridge Loan in addition to the Bridge Loan. Fees and closing costs for a bridge loan typically start at 1 5% to 3% of the total loan sum, and could consist of:
Types of Bridge Loans
Bridge loan variations are frequently caused by the wide range of terms that lenders offer depending on the borrower’s creditworthiness and financial requirements. Therefore, even though bridge loans aren’t always categorized into particular types, they frequently differ in terms of interest rates, repayment options, and loan terms.
There are several ways to handle interest repayment on bridge loans. Others may prefer lump-sum interest payments that are made at the end of the loan term or are deducted from the total loan amount at closing, while some lenders require borrowers to make monthly payments.
Think about a homeowner who wants to borrow $25,000 to pay the down payment on a new house but hasn’t yet sold their old one. 5% interest is charged on a $25,000 interest-only bridge loan from Lender A for a period of six months. The monthly interest payment for this repayment plan is approximately $104 [$25,000 loan principal x 0]. 05 interest / 12 months]. The proceeds from the sale of the borrower’s current residence will be used to pay back the loan’s principal by the homeowner.
Lender B, on the other hand, provides a $25,000 bridge loan with a year’s worth of amortization at the same interest rate. The proceeds from the sale of the borrower’s prior property are kept in this situation. However, the total of their monthly payments, which combine principal and interest, will be about $2,140.
When you need money but don’t yet have access to a long-term financing option, bridge loans can be a great tool. However, bridge loans only last up to a year, frequently have high interest rates, and put you at risk of losing your first house. Consider these alternatives before committing to a bridge loan:
Home Equity Line of Credit (HELOC)
With a home equity line of credit, homeowners can borrow money against the value of their house. HELOCs typically have 20-year repayment terms and allow for revolving borrowing by borrowers. Since they have a longer time to pay off their debt, borrowers are less likely to default and lose their homes. In addition, HELOC interest rates are typically around prime plus 2%, as opposed to the 10 5% that may be applied to bridge loans. Homeowners can use a HELOC, draw from it as needed, and pay it off when their first home sells in place of getting a bridge loan to cover the down payment on a new home.
A home equity loan allows homeowners to borrow against the value of their homes, similar to a HELOC. In contrast to a HELOC, which allows the borrower to draw money as needed, a home equity loan is a one-time payment. Home equity loan rates typically begin at about 2% above prime, like HELOCs. For homeowners who are certain of the exact amount they must borrow to pay for the down payment on their new home, this is a great option.
Homebuyers can use 80-10-10 loans to obtain a mortgage covering 80% of the cost of a home and then add a second loan for the remaining 10%. The 80-10-10 financing strategy requires a home buyer to put down just 10% of the purchase price, hence the name. The proceeds from the sale of the borrower’s primary residence can then be used to pay off the second mortgage.
Business Line of Credit
Businesses can access a revolving loan called a business line of credit to pay for urgent expenses. Lines of credit, unlike bridge loans, are not made in one lump sum, so the borrower only pays interest on the amounts they actually use from the line. The typical loan term is between a few months and ten years, and the interest rate, which varies depending on the lender, can be as low as 7% from traditional banks.
However, keep in mind that getting a business line of credit from a traditional bank can be very challenging, and online lenders charge higher rates ranging anywhere from 4 to 8 percent. 8% to 99%. Because of this, business lines of credit should only be used to meet very urgent needs, such as replenishing inventory or paying for unforeseen expenses.
Bridge Loan Pros and Cons
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A small business owner with experience in real estate and financing, Kiah Treece is a licensed attorney. Her primary goal is to help people and business owners take control of their finances by demystifying debt. The Forbes Advisor editorial team is independent and objective. We receive money from the businesses that advertise on the Forbes Advisor website to help fund our reporting efforts and to keep providing this content without charge to our readers. This compensation comes from two main sources.
FAQ
What are the disadvantages of a bridging loan?
Given that bridge loans typically have incredibly short terms, the lender must put in a lot of effort. This explains why the loans have such high interest rates, usually around 8 percent. 5% and 10. 5% of the full loan amount.
What are the advantages of a bridging loan?
The main benefit of bridge debt financing is flexibility. It gives borrowers access to short-term capital that enables them to meet any immediate financial obligations, close on real estate deals quickly, finish renovations, or find new tenants for the building.
What credit score is needed for a bridge loan?
The lender can be reasonably confident they will recover the loan amount because the sale of the current property will automatically pay off the bridge loan. A private money bridge lender should have no trouble approving someone with a credit score of 650 or higher.
Is there an alternative to a bridging loan?
Because they can be used to quickly release equity from a property, fast house buying companies are frequently thought of as an alternative to bridging loans. While quick house sale companies buy the asset from you when you release money using bridging finance, you still own the property.