If you want to invest in real estate, a bridge loan can be a great source of financing for you. A bridge loan is a kind of short-term loan that can have a term of anywhere from two weeks to three years. However, the majority of bridge loans last for six months to 12 months. When taking out this type of loan, you’ll be provided with short-term funding that you can use to close on a property that you’re investing in or purchase another property while you wait for your current one to be sold.
Many homeowners encounter a two-step transaction that involves purchasing a new building while trying to sell an old one. You should consider seeking a bridge loan when you need to bridge two separate financial transactions. If standard bank financing isn’t available to you, or you need to move quickly to close on a transaction, a bridge loan may be your best bet. This article takes a closer look at how bridge loans work as well as the pros and cons of this specific type of loan.
How Bridge Loans Work
When looking at how bridge loans work, they usually have the same requirements as a standard mortgage. For one, you’ll need to have at least some equity in the property in question. Let’s say you have a home that’s worth $500,000 but still has $300,000 left on the mortgage. You would have $200,000 in equity. The loan needs to be backed by collateral, which is why it’s important that you have access to equity.
The terms of your bridge loan will likely last for around six to twelve months until you will be required to pay back the loan. These loans are designed specifically to be used on a short-term basis to assist you during a period of transition. Keep in mind that the majority of lenders that can provide you with bridge loans won’t go higher than a loan-to-value ratio of 70 percent, which means that you will need to maintain at least 30 percent equity within the current asset that you own in order for a bridge loan to be provided to you.
There are many reasons why it could be ideal for you to obtain a bridge loan, which includes:
- It will provide a safety net in the event that you sell your old home before purchasing a new one so you won’t have to rent
- Allows the purchase of a new home, without notable restriction, while placing a current home on the market
- Being able to put a down payment on a new home without using the profits from selling your old one
- Payments can be deferred or interest-only until you are able to sell your old home, which provides a certain amount of flexibility
While bridge loans can be beneficial for a variety of situations, there are some negatives to this type of loan that you should consider before applying for one. These cons include:
- Bridge loans have exceedingly short lifespans and require a significant amount of work from the lender, which is why the loans can have relatively high-interest rates that can be around 8.5-10.5 percent of the complete loan amount
- The closing costs and fees pertaining to this loan can be high and may drive up your costs
- The lender that provides you with the loan could decide to use a variable prime rate, which means that your interest rate would increase over time
- There’s always the possibility that your home wouldn’t be able to be sold during the six to twelve month term of the loan, which would put you in a problematic situation
- These loans are generally considered to be more expensive than a traditional home equity loan
Bridge Loan vs. Home Equity Loan
Before you consider applying for a bridge loan, it’s recommended that you compare bridge loans with home equity loans, which are somewhat similar in how they work. Just like bridge loans, a home equity loan is secured, which means that your current home will be used as collateral. While it might sound risky to use your home as collateral, you should have enough time to sell the current property before the term of the loan ends.
While both of these loans are considered to be secured loans, they are otherwise very different. For one, home equity loans are generally long-term loans. The majority of these loans will come with longer repayment periods that can last anywhere from 5-20 years, which is much higher than the six to twelve months that is standard with a bridge loan. Because of the longer terms with home equity loans, interest rates are typically lower as well. If you are able to effectively qualify for a standard home equity loan, you can expect the interest rates you pay to be around six percent, which is decidedly lower than the 8.5-10.5 percent that comes with bridge loans.
A home equity loan is actually riskier for you when compared to a bridge loan. While bridge loans also come with the risk of being unable to sell the property, a home equity loan puts you at the risk of paying for three separate loans in the event that your old home doesn’t sell on time, which include the original mortgage, the new mortgage, and the home equity loan that you’ve received.
If you’ve built up a significant amount of equity in your current home by paying a substantial amount of the old mortgage, a home equity loan might be the better option for you. There are risks to both loan options that you should keep in mind. However, a bridge loan is typically the better option as long as it fits with your situation.
Find the Right Lender for Your Bridge Loan
The key to obtaining the right bridge loan is to make sure that you choose the correct lender. Likely the easiest way to identify the right lender is to take some time to compare various rates and terms. While the lowest interest rate doesn’t always equate to the best deal, it should be a heavy consideration. If you can find a lender that will provide you with a loan that has interest rates of 7.0-8.0 percent, these would be considered good rates. Short-term loans invariably have high-interest rates, which may cause some anxiety when you’re looking for the right loan. However, doing your research for the best rates will help you in the long term by saving you a substantial sum of money.
It’s also highly recommended that you obtain referrals from friends and family members who may have worked with a lender in the past. Keep in mind that not all lenders offer bridge loans, which will automatically reduce the number of options available to you. Before you agree to a loan from the lender you’re interested in, you should think about visiting their offices to gain a better understanding of their operations and to make sure that they’re legitimate. While it’s important that you obtain low-interest rates with your bridge loan, you might also want to think about looking for lenders that offer low origination fees.
Once you’ve found the right lender, all that’s left for you to do is apply for the loan. Bridge loans can be very beneficial if you’re searching for short-term financing that will bridge the gap between two financial transactions. If you are wholly confident that your current home can be sold within a few weeks to several months, bridge loans are an excellent way to help you get out of your old home and into a new one without needing to worry about an uncertain period between the two transactions.
*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.