What Is A Bridge Loan?
When a person or company opts for a short-term loan until they secure permanent financing or do away with the current financial obligation, it is termed a bridge loan.
With this financing, borrowers can meet their existing obligations with the help of immediate cash flow.
These are short-term loans by nature, meaning their durations typically only last up to a year.
However, despite their short term, they are accompanied by higher interest rates and require some collateral in the form of inventory or real estate.
Read on to see how they work and when this type of financing can come in handy.
How It Works
Bridge loans, also known as bridging loans, bridge financing, gap financing, bridge lending, or swing loans, are designed to help bridge the gap when there is a need for cash that is not readily available.
Both individuals and companies can customize these loans to suit their situation and requirements. It can help homeowners purchase a new property as they await the sale of their existing home.
For instance, with bridge financing, homeowners can use their built-up equity in their existing house for the down payment of their new home. This financing is also accessible when they await the sale of their current home.
Still, bridge loan rates are higher when compared to other options like a home equity line of credit (HELOC).
Moreover, borrowers who have not completely repaid their outstanding mortgage will have to make double payments; one for the mortgage until the house gets sold and the other for the bridge loan.
Let us explore two areas where bridge lending solutions come in very handy.
- It is ideal for businesses to opt for this financing method while they are awaiting the approval of a long-term financing option. These loans can help cover the expenses in the interim.
- Companies that go for a round of equity financing and expect to receive funds within six months remain ideally placed to use this financing option.
- It is possible to take care of several expenses like rent, payroll, inventory, and utilities with this type of borrowing until cash is more readily available.
- Homebuyers who expect a gap between the sale of the existing property and purchase of the new property can opt for this financing option.
- The qualifying criteria are tough given bridge loan lenders only offer these loans only to those borrowers who have a low debt-to-income ratio and better credit score.
- Homebuyers gain a lot of flexibility because these loans can help roll the mortgage of two houses together.
- Borrowers must have significant equity in their existing home because lenders normally offer these loans in an amount up to 80% of the total value of both the properties combined.
- Alternatively, if you have cash savings in hand, these should probably be put to use in these situations.
How Do Bridge Loans Compare To Traditional Loans?
The biggest difference between the two is that bridge loans have a swift process when it comes to application, approval, and funding.
However, these loans are issued for short-term purposes only and come with significant origination fees and higher interest rates.
Borrowers usually are comfortable with the terms given they gain access to much needed funds rapidly.
Since these are short-term loans, a higher interest rate does not add up as significantly when compared to 15 or 30-year mortgages.
It is designed to help borrowers solve their problem of immediate cash access.
Best of all, bridge loans do not have any prepayment penalties, meaning you can clear the debt in one payment without paying any penalty interest or fines for early loan retirement.
The Pros And Cons
Here are some valuable pros and cons of bridge loans worth exploring if you are considering this financing method.