Bridge loans are a type of short-term financing that is used to help tide over a business during a time where they lack cash. These funds are quickly provided and act on a time-sensitive opportunity or sustain the business. Depending on the lender, the borrower can secure the funds in one day. Bridge loans can be repaid in months or up to 2 years and have flexible terms. Borrowers can pay off the loan before or at maturity therefore many small businesses find this type of loan idea because they are free of prepayment penalties.
How Does a Bridge Loan Work?
Bridge loans can be used for many purposes such as using them for homes or businesses. In real estate, a bridge loan can be used to buy another home before you sell the current one. Businesses can use bridge loans to ensure operations are running smooth while they search for an investor.
Benefits of a Bridge Loan
Bridge loans benefit home buyers because they can buy a new home and put the existing home on the market without any restrictions. They can still buy a new home even after removing the contingency to sell under certain circumstances. The application process for a bridge loan takes less time than other traditional loans so it is great for quick financing.
Drawbacks of a Bridge Loan
A drawback for home buyers is that interest costs will be higher than on home equity loans or other traditional loans. Lenders require a certain amount of equity in your existing home to qualify. In order to be approved for a bridge loan, you must have strong credit and financial history. If you find that your financial situation is poor, you could have difficulties in being approved for a loan.
When You Should Use a Bridge Loan
Some of the ways that you can use a bridge loan is if you are in the following situations:
- Sellers will not accept contingent offers.
- You cannot afford down payment without proceeds from your current house.
- You are confident that your house will sell but want to secure a new home before listing it.
How to Qualify for a Bridge Loan and How to Find a Lender
To qualify for a bridge loan there are some requirements you must meet.
- Enough income to cover payments
- At least 20% of equity in your home
- Must commit to pay off the loan quickly
Not every lender has bridge loans as an option, but you can look at the following lenders who may offer this for you such as:
- Institutional lenders: start with your local bank and ask if they have bridge loan programs available. The approval process may be easier if you have deposits with a bank.
- Alternative lenders: mortgage bankers and brokers have relationships with alternative lenders. They can find a bridge loan source if your bank does not offer them.
- Hard money lenders: these type of lenders are private investors who are looking for high returns on short-term real estate loans. However, interest rates will be high, and you can expect prepayment penalties and fees range between 2 and 10 percent, depending on your credit profile.
Bridge Loan Alternatives
Fortunately, there are other alternative options to consider if you want to avoid using a bridge loan. Here are some of the other options to consider:
- Home equity line of credit (HELOC): if you already have a HELOC, you can use it toward a down payment on your new home. There are some drawbacks to this like you might have to pay a close-out fee when your home sells and the HELOC is paid off and closed.
- 401(k) loan: your rates and payments can be lower if you use your retirement savings account rather than a bridge loan. It could be more cost effective to take out a 401(k) loan and avoid the closing costs and high interest rates that come with a bridge loan.
Should You Get a Bridge Loan?
Depending on your situation, bridge loans can be an excellent or poor option. Consider a home equity line of credit, personal loan, or a 401(k) loan instead if it is a poor option for you. Be sure to look at your financial situation to determine what is best for you.