Last Updated: August 19, 2022
Wouldn’t it be ideal to attain immediate cash flow to cover current expenses or debt obligations while waiting for permanent financing? Well, you can with bridge financing—a short-term loan that can get you back on your feet in no time. This guide addresses how a bridge loan works, its pros and cons, and when it’s a good idea to obtain one. We also list alternatives to such a loan to help you choose the best option.
What Is a Bridge Loan?
A bridge loan is a short-term loan that provides immediate cash flow until an individual or company receives permanent financing or takes care of a debt obligation. This type of financing is also known as a bridging loan, bridge financing, interim financing, gap financing, or swing loans.
Regardless of the name, such a loan typically entails collateral and has relatively high-interest rates in exchange for the convenience of quick approval and access to cash.
A bridge loan is common in real estate transactions and various branches of business when companies anticipate permanent financing but need immediate cash flow to cover operating (and other) expenses.
|DID YOU KNOW? After applying for a bridge loan, you can wait a couple of days to two or three weeks to receive money. But some traditional loans can take up to two or three months.|
How Does a Bridge Loan Work?
Compared to traditional loans and other financing arrangements, a bridging loan has higher interest rates. The typical repayment period of this short-term loan is a few months to a year. It also involves collateral—most likely a property—and includes additional costs.
Depending on the circumstances, a bridging loan can become a primary mortgage on your house or take the position of a new mortgage.
First Mortgage Bridge Loan
If borrowers take a bridge loan to pay off their existing mortgage and make a down payment on a new house, the loan becomes the primary mortgage they can repay once they sell the property.
Second Mortgage Bridge Loan
If borrowers use bridge loan money to make a down payment on a new house—and still have a mortgage on their first house—the first house serves as collateral, making the bridge loan a second, new mortgage.
The bridge loan definition includes short-term loans that comprise collateral and, therefore, can be risky for homeowners who don’t manage to sell their property in the loan’s repayment period. So when considering this option, always conduct thorough research that includes the average time it takes to sell a property similar to yours in a specific location.
|DID YOU KNOW? Depending on the bridge loan lender, repayment plans may include fixed or interest-only monthly payments or paying the total amount on a set due date. Sometimes, you can secure a few months payment-free, but the interest will accrue—so have this in mind when looking for a suitable bridge loan example.|
|A bridge loan is a short-term loan that can provide immediate cash flow to cover current expenses or debt while waiting for permanent financing to kick in.|
|These loans usually come with high-interest rates and additional fees, depending on the lender and the amount borrowed.|
|Bridging loans are often used in real estate transactions and provide the buyer with the opportunity to put a down payment on a desired property before selling a previous one.|
|These loans have requirements that include collateral—typically property or land.|
Who Can Benefit from Bridge Loans?
Bridge financing can be an excellent solution in some cases, despite high bridge loan rates. For example, they’re often used in the real estate industry, removing the stress of homeowners who need to sell immediately and providing them with peace of mind.
As previously noted, when buyers wish to buy a new house before selling their old one, they may opt for bridge financing to make a down payment on their new home. The property they want to sell serves as collateral for the bridge loan.
A homebuyer may ask, what is a bridge loan, and when should I get one? You should attain such a loan:
- When finding a house you like but can’t afford to make the down payment until you sell your existing property.
- When you need to move quickly—due to work or other reasons—and can’t wait for your house to sell.
- When you want a house that’s on the hot market, where properties sell quickly.
- When the seller is not willing to accept a contingent offer, so you must wait for your house to sell to move forward with the purchase.
In the cases listed above, it might be a good idea to talk to a bridge loan lender and use the money to make a down payment and repay it using a traditional mortgage with lower interest rates.
How to Get a Bridge Loan?
When in need of immediate cash, individuals or companies can reach out to banks or another bridge loan lender. If you decide to go for a bridge loan, note that the cost depends on the lender.
You can also obtain these loans with credit unions or other financial institutions and online lenders who offer interim financing. Sometimes, however, the most logical solution to where to get a bridge loan is from your current mortgage provider.
The application process is similar to applying for a mortgage. The lender will consider your credit score, debt-to-income ratio, and credit history. But note that some lenders also require at least 20% equity in your current home, i.e., you can borrow up to 80% of your loan-to-value ratio (LTV).
|DID YOU KNOW? Before you decide on a lender, verify their trustworthiness. For example, you can check if they have the required license in your state by visiting the Nationwide Multistate Licensing System Consumer Access.|
Cost of a Bridging Loan
Compared to traditional mortgages, bridging loans have higher interest rates that depend on the amount borrowed, creditworthiness, and the bridge loan lender. They also encompass terms and conditions, including repayment plans.
Typical interest rates for these loans are between 8.5% and 10% but can go even higher for business bridge loans that can exceed a whopping 20%. Besides higher interest rates, bridging loans come with the following additional expenses.
- Origination fee
- Wiring fee
- Notary fee
- Escrow fee
- Appraisal fee
- Title policy
- Administration fee
These costs depend on the lender, location, and the loan amount, typically ranging between 1.5% and 3% of the amount borrowed.
Pros and Cons of Bridge Loans
Like other financial products, bridge loans assume specific elements to consider.
There are 3 pros:
Purchasing a New House
If you find a house you like—especially on the hot market—this loan will allow the possibility to buy (or make an offer) without waiting to sell your other property, making your offer more appealing to sellers.
Extra Emergency Money
If you need to change locations before you sell your house or have an immediate debt obligation, a bridge loan provides you with the necessary funds and peace of mind.
Quicker Approval and Funding
A bridging loan is excellent for emergencies because it’s typically approved and funded much quicker than traditional loans, as long as you meet the requirements.
The 5 cons are:
Higher Interest Rates
The convenience of quick funding comes with high interest rates.
Minimum 20% Home Equity
You must have a minimum of 20% home equity in your current home before getting this type of loan. Because these loans include collateral, some bridge loan lenders may include this in their bridge loan requirements when deciding to approve your application.
Origination and Additional Fees
Not only are interest rates higher with interim financing, but additional costs can add up as well.
Requires Stable Finances
You typically need a good credit score and other financial requirements to obtain a bridge loan. Otherwise, you might consider mortgage lenders who accept people with bad credit.
Swing loans come with collateral—typically your house—and the lender can foreclose if you fail to repay the loan. So make sure that your property sells in the required time or have a backup plan.
Alternatives To a Bridge Loan
What is a bridge loan in real estate? After considering this question via this guide, you may decide that a bridge loan doesn’t fit your needs. Instead, note the following alternatives to provide necessary cash flow.
Home Equity Loan
You can borrow money against your home with a home equity loan. The repayment period and interest rates are much more favorable than interim financing. So this can be an excellent option if you know exactly how much money you need.
A home equity line of credit (HELOC) allows you to draw a line of credit against your home equity. But unlike a home equity loan, HELOC permits you to withdraw money on a revolving basis. With both HELOC and home equity loans, the repayment period is typically up to 20 years, allowing more freedom and less chance that you’ll lose your home compared to swing loans. And interest rates are usually significantly lower than bridge loan rates.
Business Line of Credit
If you run a business, a business line of credit is a revolving credit to cover necessary expenses. You can withdraw from it as needed and pay interest only on the portion of the money you’ve used. These loans, however, are not easily obtained from traditional banks and can come with high-interest rates, especially from online lenders. But the repayment period is more extended than with swing loans.
Are Bridge Loans a Good Idea?
After carefully considering our guide, you should be able to determine if you need a bridge loan or other alternatives to gap financing. You can decide if the higher cost and greater risk of bridge financing are worth more than what you can lose without the needed cash flow.
This depends on the lenders’ requirements and your financial situation. Most lenders allow you to borrow up to 80% of your loan-to-value ratio (LTV). This means that you can borrow up to 80% of the combined value of the property you’re selling and the one you’re purchasing.
To qualify for a bridge loan, you must meet your credit score, credit history, and debt-to-income ratio requirements. In addition, some lenders may ask for at least 20% of your current home’s equity.
What is a bridge loan? Such loans are not bad, but they do have drawbacks. They cost more compared to traditional loans and require collateral. On the other hand, they provide almost immediate funding.