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Bridge Loan: Everything You Need to Know

What Exactly Is a Bridge Loan?

In preparation for your upcoming relocation, have you considered selling your home? It’s possible that doing both at once will put a burden on your budget. 

Especially if you’re going to be utilizing the money you get from the sale of your present house as part of the down payment on your next one, as many purchasers do. You may rest easy knowing that a bridge loan is there to smooth over any bumps in the road to homeownership.

What Exactly Is a Bridge Loan?

In order to bridge the financial gap between the sale of one home and the purchase of another, borrowers can take out a bridge loan for a shorter length of time. In the event of an unexpected life change, such as relocating for a new job, a bridge loan may be the best financial option for homeowners.

Similar to mortgages, home equity loans, and home equity lines of credit, the equity in your current house can be used as security for a bridge loan. However, a bridge loan shouldn’t be considered a replacement for a mortgage. Bridge loans are short-term financial solutions often repaid within a year to three years.

How Do Bridge Loans Work?

Bridge loans, which are employed by sellers in sticky situations, come with a wide range of fees and interest rates. There are bridge loans that are structured to pay off the existing mortgage in full at closing, and there are other loans that just add to the existing mortgage. 

While the interest on certain loans is paid monthly, on others it is paid all at once at the beginning or conclusion of the loan’s duration. However, most have a few features in common:

  • The borrower’s previous residence serves as collateral for these loans, which typically have durations of six or twelve months.
  • A bridge loan is a short-term loan used when a permanent mortgage cannot be secured for a property.
  • Interest rates may be set at a variable range between the prime rate and prime rate plus two percentage points.
  • Credit scores and debt-to-income (DTI) ratios are just two of the many indicators evaluated to determine whether or not you’ll be approved for a bridge loan, just as they would be for a traditional mortgage. 
  • There is a typical cap of eighty percent on the amount of equity a lender will loan you against your primary residence.
  • It’s not uncommon for bridge loans to come with high-interest rates.

Most borrowers seek bridge loans to cover costs until they can sell their current property, but these loans typically do not protect the lender in the event that the sale goes through. If the bridge loan extensions ran out or if you had problems selling your current home, the lender could even go so far as to foreclose on the previous property.

Because of these potential drawbacks, it’s wise to thoroughly weigh the pros and downsides of a bridge loan in light of your financial situation and the current housing market conditions.

Example of a Bridge Loan

For example, if you have a $60,000 mortgage balance and your home is worth $120,000, you decide to take out a $90,000 bridge loan. 

Out of the total $90,000, $60,000 would be applied to the mortgage and $5,000 would be used to cover the costs of the sale’s closing. Assuming the sale of your present house proceeds well, the bridge loan would give you $25,000 to put toward your next purchase.

Bridge Loans: Pros and Cons

Bridge loans, like any other type of loan, come with potential benefits and drawbacks for borrowers. It’s smart to do your research and consider all of your options before asking for a loan of any kind.

Pros

Quick approval: A bridge loan can be closed in a fraction of the time it takes to close on other loans.

Flexible purchasing: A bridge loan might provide the financing necessary to complete the purchase of a new house before the sale of your present residence has actually taken place. Then, if you locate a house you really like, you can perhaps buy it before your current one sells.

Eliminate conditions from your offer: Offers that aren’t contingent on the buyer’s selling their current residence may receive greater consideration from sellers.

There will be less stress related to housing: A bridge loan can enable you to buy a new home before you’ve even sold your old one.

Cons

Costly interest rates: Compared to longer-term loans, bridge loans offer less profit potential for lenders, hence they typically carry higher interest rates.

Origination fees: In most cases, a borrower should expect to pay some sort of “origination fee” while working with a lending institution. Bridge loans may have hefty origination fees, up to three percent of the loan amount.

Equity required: Many lenders will require a certain level of equity in your present home, say twenty percent, in order to qualify for a bridge loan, which will be used as collateral for the purchase of your new property.

Strong financials: If you need a bridge loan, you probably don’t have the best credit or financial situation. 

Lenders might establish criteria for qualifying for loans, such as minimum credit ratings and debt-to-income ratios. Getting a bridge loan may be challenging in general if your financial condition is precarious.

How to Qualify for Bridge Loans

Standard qualifications such as debt-to-income ratio, home equity, credit score, and household income may be looked at by a lender to determine if a borrower is qualified for a bridge loan. A good track record with a previous mortgage application will aid your cause. 

Qualification is based in large part on the amount of equity you have in your current house. If you are deemed an excellent debtor by your potential lender, you may receive approval for your bridge loan much more quickly than you would for a conventional mortgage.

When to Consider a Bridge Loan

When a homeowner wants to buy a new house before selling the old one, they frequently turn to a bridge loan. You should consider a bridge loan if:

  • You’ve found a new place to live, but the seller of your current property won’t accept a sale-in-conditions offer.
  • Without selling your present house, you won’t have enough money for the down payment on your next purchase.
  • The settlement on your new home will occur after the closing on your current home.

Alternatives to Bridge Loans

In some cases, a quick accumulation of cash can be acquired without resorting to a bridge loan. After all, you have access to a variety of other financing options that can support your needs even in a tight spot. Here are some other options to consider.

  1. Home Equity Loans. One popular substitute for bridge loans is home equity loans. You can take out a loan based on the amount of equity you currently have in your property. Bridge loans often have higher interest rates and shorter repayment periods than home equity loans, which are typically offered for much longer (up to twenty years).
  1. Home Equity Line of Credit (HELOC). HELOC is similar to a second mortgage in that it allows you to borrow money against the equity in your home, but with better terms.
  1. 80-10-10 Loans. With an 80-10-10 loan, you put down ten percent on the purchase price of a home and take out two mortgages, one for eighty percent of the price and another for the remaining ten percent.
  1. Personal Loans. The collateral for this type of loan is typically the borrower’s possessions, and the interest rate and repayment schedule are negotiable depending on the lender.
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