In real estate transactions, a bridge loan is often the source of cash flow during a transitional period, such as moving from one home to another. Homeowners take these loans to put more cash in their pockets, pay off existing debt, or finance the purchase of their new home. That being said, just like other types of financing, there are advantages and disadvantages to a bridge loan.
In this blog, we’ll explain how you can use a bridge loan to fill a financing gap.
Defining a Bridge Loan
A bridge loan is a short-term financing product that provides funding and capital until an individual or company can secure permanent financing. Another name for this type of financing is swing loan. Typically, terms are short- 6 months to 1 year. In most cases, they are used to purchasing a new home before your current one sells.
How Does it Work?
A bridge loan is typically used by a seller that finds themselves in a tight spot or needs to move quickly. The terms, fees, and conditions vary between lenders and transactions.
Some of the most common reasons people seek a residential bridge loan are:
Inability to afford a down payment on a new home without the current one selling
The closing date for a new purchase is scheduled before the closing date of your current home
Need/want to secure a new home before selling your current one
Need to quickly secure a new home
The seller is not comfortable with contingent offers
Generally, there are 2 options for individuals who need a bridge loan:
Use as second mortgage to put toward down payment of new home until current one sells
Use one large loan to pay off current mortgage and put the rest of the money toward a down payment on your new one
Characteristics of a Bridge Loan
Some of the characteristics of a bridge loan are:
6 months to 1 year terms
Secured by current home as collateral
Must agree to finance new mortgage with the same lender
Vary in interest rates, usually slightly above prime
Of course, keep in mind that the application process is very similar to that of a conventional mortgage. The loan officer will consider several factors: credit score and history, DTI ratio, and more. In addition, most lenders allow you to borrow up to 80% of your loan-to-value. Basically, you need at least 20% equity in your current home to get a bridge loan.
Advantages & Disadvantages of a Bridge Loan
Just like with other forms of financing, a bridge loan has several advantages and disadvantages. We’ll explore those below:
Allows you to purchase a new home before selling your current one
Can make a contingency-free offer on a new home
Provides additional funds in case of a time-sensitive transition
Helpful short-term financing solution to get through uncertain times
May be able to get no monthly payments for a few months
Potential for deferred payments or interest only payments until current home sells
Higher interest rates and APR
Require at least 20% equity in current home
May have to use same lender for your new mortgage
May have to manage 2 mortgages at once until your current home sells
Difficulty selling current home may lead to issues, including foreclosure
You can get a bridge loan from a variety of lenders, but most often, it is your current mortgage provider that provides it. If you are interested in a bridge loan, your current lender should be your first choice.
As you can see, a bridge loan is a helpful financial tool for getting the funding you need to secure a new home before your current one sells. If you need more information or want to explore your options, contact Ideal Financial Group. We can answer any questions you have about getting a bridge loan and more.