How Do Bridge Loans Work?
Conventional mortgages aren’t always a feasible option for real estate investors or individuals seeking financing to cover the interim between the purchase of a new home and the sale of their current home. As an alternative, some borrowers opt for bridge loans — short-term financing that can be easier and faster to get than a conventional mortgage.
Bridge loans were originally called as such because the borrowed amount helped to bridge the gap between a new home purchase and a current home sale. But now, they are also often used by real estate investors and those interested in flipping houses.
They can also be useful for businesses that need cash to cover a few bad months or those who are waiting for long-term financing options to be approved. But, before seeking a bridge loan, prospective borrowers should consider first understanding how they work so that they can determine if a bridge loan is the best loan option for their needs.
How do bridge loans work?
Unlike conventional mortgages, which are usually designed to be paid off in 15, 20 or 30 years, bridge loans are typically meant to be repaid off anywhere from six months to two years, depending on the terms of a specific loan. Ideally, a borrower would want to pay off a bridge loan as quickly as possible, since the interest rates on bridge loans are typically higher than those of conventional loans. It is also important not to default on the loan, since the loan is usually backed by the borrower’s current property. If the borrower defaults on the loan, the money lender could foreclose on the property.
Getting approved for a bridge loan is also not as difficult or as time-consuming as getting approved for a conventional mortgage. Money lenders typically only require that the borrower has 20% equity or more in their current home, as it will be used to secure the loan. Borrowers should also be advised that bridge loans may also have origination fees, closing costs, and appraisal fees. Borrowers should be sure to read all the terms and conditions related to a particular loan by a money lender so that they are informed of all the fees, repayment requirements, etc.
When to use bridge loans
As mentioned above, there are quite a few reasons bridge loans are a more suitable option than conventional or personal loans. One of the original purposes of the bridge loan was to provide homeowners with funding to purchase a new home when they haven’t yet sold their own home. While today it is more common for homebuyers to seek a mortgage for a new home while attempting to sell their home at the same time, there are many situations in which this doesn’t happen.
For example, a homeowner might have to suddenly move to another location for work purposes. Or, they might be just planning to move to a new home but haven’t had luck selling their current home yet. Without the sale of their current home, homeowners might also face difficulty getting enough cash together for a down payment on a new home. With a bridge loan, the homeowner can pay a down payment and also cover the mortgage on their first home; essentially, the homeowner is acquiring funding to help bridge the gap financially between the two real estate transactions. Then, when the sale of the first home is complete, the borrower can repay the bridge loan with the money they received from the sale.
Homeowners must also be aware of the risks involved with bridge loans, particularly if they are unable to sell their current home within the term limit of the bridge loan. But it can be a very good option if they are currently in a seller’s market.
Another common use for bridge loans is for real estate investments. Real estate investors and house flippers can use bridge loans to get quick funding to purchase a property, and avoid the hassle and stricter requirements of conventional mortgages. Borrowers can get the financing quickly, use it to perform renovations and repairs on a house flip, sell the home and repay the loan.
When researching bridge loan options from different money lenders, borrowers should be aware that there may be different repayment methods and loan term options available. Borrowers should be sure to inquire about all the terms and conditions so that they can make an informed decision.