Are you making a sudden transition, like a work-related relocation? You may want to quickly sell your current home and use that money to purchase a new one at the new location. But closing a deal for a home isn’t easy and may not be as fast as you want. Plus, rarely will you get the closing dates to align to complete both transactions on the same day.
That’s where a bridge loan can help. It provides you with temporary funding to buy the new home. However, like other loans, this type of short-term funding comes with risks. Here’s everything you need to know about a bridge loan.
A bridge loan, also known as a swing loan, is a short-term loan used to purchase a new property before selling your current home. With this loan, you can move into your new home and then focus on selling the previous one. Once the first home is sold, you can use the proceeds to settle the bridge loan and be left with just the mortgage on the new property.
Think of it as interim financing or gap financing designed to meet your immediate cash flow needs during a transitional period. Apart from financing a new home, business owners can also use this loan to pay off an existing debt obligation.
Essentially, a bridge loan enables you to get from point A to B in a transaction until you can secure more permanent financing.
According to a Bridging Trends report, most people took a bridge loan for investment purchase, with 24 percent of all bridging loans used for this purpose. Other reasons people opted for bridging loans include:
Other reasons that may necessitate applying for a bridge loan include:
Just like mortgages, secured loans, and home equity loans, a bridge loan is secured by your current home as collateral. But unlike mortgages, which have a repayment schedule of up to 30 years, the average term to repay bridging loans is 12 months. Some lenders will even offer terms as short as six months.
Usually, the amount and period depend on how much equity you have. ‘Equity’ is the difference between your home’s current market value and what you owe. In most cases, the maximum loan, plus interest, may be limited to 75-80 percent of your current home’s value and the value of the property you wish to buy.
Typically, you’re required to pay the interest along with the principal amount at the end of the loan period in one lump sum. Some lenders may require upfront interest payment, while others can allow several months before making a single payment.
Basically, the terms vary from one lender to another.
Apart from being short-term, bridging loans have several unique features. These are:
Applying for hard money bridge loans is similar to applying for conventional mortgages, but with less stringent requirements, making the application faster and easier. The lender analyzes standard credentials like your debt-to-income (DTI) ratio, how much home equity you have, your credit score, and possibly your household income.
But, there are some key differences between a bridge loan and a traditional mortgage. The most notable one is that you’ll need to choose whether to take the bridge financing as a first or second mortgage.
Generally, a hard money lender will have a lower loan-to-value ratio (LTV) compared to conventional mortgages obtained from banks. Usually, you can borrow up to 75 percent of the value of your home.
Note that, regardless of whether you choose a first- or second-mortgage bridge loan, the lender will want to confirm that you have sufficient equity in your property for protection against default. Generally, you want to ensure you have more than 20% equity before applying for a bridging loan.
Again, the terms vary from one lender to another. The bridging loan application can be approved within 24 hours, but funds may take a few days to weeks to be released.
Here are some of the lending specifications for a bridge loan:
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Bridge loans make a lot of sense in specific situations, particularly where time is of the essence. You’ll want to ensure that the pros outweigh the cons before applying for bridge financing.
A faster way of obtaining funds. The loan application, approval, and release of funds take shorter than traditional loans offered by banks. It means you can receive funds quicker than with traditional loans.
Cash in hand. Did you know that the top reason startups fail is a lack of cash flow? Say you own a construction company. It’s common to get paid at the beginning and end of a project. What if you run out of cash along the way, to cater to daily expenses, including paying your workers? A bridge loan gives you access to cash in hand to cover upfront costs while you await payment.
Increased flexibility. Bridge loans allow you to utilize equity in an existing property to purchase a new one. So, if you find a home you love, you can buy it without waiting for your old house to sell.
No contingencies from your offer. Sellers prefer homebuyers with offers that aren’t contingent upon the sale of their existing homes. A homebuyer with enough equity in their existing homes should apply for bridge loans to purchase their dream home.
Access to clients with bad credit. Lenders aren’t so keen on their client’s financial standing, like their creditworthiness and income. Instead, they are more focused on the borrower’s property and existing equity to approve or deny a loan request. This means that borrowers who have been denied loans by banks due to poor credit or other financial issues like foreclosures and bankruptcies can access bridging loans.
High-interest rates. The ease with which one can access hard money bridge loans comes with one major caveat – that of high-interest rates.
Origination fees. Lenders charge fees to “originate” a loan, which is often around 2 points. As a borrower, you’ll also need to pay all the standard real estate transaction fees, including title insurance, escrow, home inspection, underwriting fees, origination fees, and appraisal fees, among others.
Home equity requirement. Lenders typically require borrowers to have at least 20% home equity.
Collateral. Bridge loans are secured, meaning you’ll have to pledge your home or other assets as collateral.
Since bridge financing is a specialized product, only a minority of mainstream banks and other financial institutions will consider offering them. However, there is a vast market of bridge loan providers to check out. This includes:
Undoubtedly, a bridge loan is an attractive option for borrowers in need of quick cash flow. This type of loan can help you move into your new home without wanting to sell the current one. It can also come in handy if you can’t raise a down payment for a new purchase unless you sell your existing one.
That said, it’s imperative to first understand and weigh the risks before applying for a bridge loan.