Bridge loans are true to their name—in home buying, let’s say you want to buy another home before you’ve sold your existing one. What do you do? You take out a bridge loan, something to literally bridge the gap from one major purchase to the next.
What Are Bridge Loans?
At their core, bridge loans are merely temporary loans, anchored in the collateral being your existing home, and the homeowner is effectively borrowing the down payment on the new home instead. Bridge loans aren’t for everyone, even though they do seem like the ideal situation, but as you know in the world of financing, if something seems too good to be true, it’s because it is—or is slapped with a high-interest rate or some other catch-all.
Businesses also are attracted to the idea of bridge loans for when expenses arise, inventory is needed, or they are waiting for long-term financing. A business may opt to use a bridge loan to provide for working capital in order to cover a number of different expenses like payroll or inventory costs. In real estate, property or house can be used as collateral, but if a business chooses to utilize a bridge loan, then inventory can be used as collateral instead.
Bridge Loans Work
Bridge loans work differently than the standard underwriting approach for more commonly acquired loans. Not all lenders have a set-in-stone book of guidelines for bridge loans with minimum FICO scores or debt-to-income ratios for their potential debtors, so many lenders choose to go by the combined value of the two properties. Often times, lenders will still choose beneficiaries with excellent credit scores, low debt-to-income ratios, and only offer bridge loans if the two properties in question are worth 80% of the loan itself.
There are unbeatable benefits of bridge loans, which make this type of loan so attractive for real estate purchases. A homeowner can purchase a new home when in a bind and the current home they’re in hasn’t sold yet, and they might not have to make monthly payments for a few months until there’s steady cash flow. For real estate, this kind of flexibility is much appreciated, as the market moves fast and can be extremely competitive. Homeowners need to close deals quickly and without having to jump over the red tape of finances, which often serve as frustrating roadblocks.
Few Things to Consider in Bridge Loans
But like anything in loans, you must consider the drawbacks before committing yourself to a bridge loan because there are a few to mull over. For a bridge loan, the interest rate is typically .5 to .10 percent higher than a standard 30-year fixed-rate mortgage. You could very well end up paying higher interest costs in the long run on a bridge loan than on a more common home equity loan, but remember you’re opting for flexibility—and paying for it.
Another factor to weigh when thinking about a bridge loan is that you’ll be making two mortgage payments, on the home you’ve just purchased and the home you still own but are planning on selling, which can place an enormous amount of stress on a person.
Lenders, depending on which lender you seek out can be flexible, too. Regardless if you’re using the bridge loan for a business or for real estate purposes, your situation and timeline are unique, and so your funding and loan should be as well. This benefit of a bridge loan is what drives people in taking them out initially because not all traditional loans can be as flexible as a bridge loan. Ideally, you can sell your old home and skirt the interest of the bridge loan.
As opposed to traditional loans, bridge loans have a faster application process, especially if you already have a previously established relationship with the lender you are pursuing the loan from. But the convenience and fast access to funds are met with short term, high-interest fees, and for the majority of lenders, a large origination fee, but borrowers will accept these pitfalls regardless in order to have access to fast funds for their situations. These bridge loans, however, are short term and can be paid off with low-interest and long-term financing, usually with no prepayment penalties.
Contact Gelt Financial for your financing needs!