Do you know what a bridge loan is? If not, then there is a brief definition to this in here. A bridge loan is a short term loan used until a company or person removes an existing obligation or secures permanent financing. This allows the user to meet present obligations by rendering quick cash flow. Bridge loans are short term, up to one year, have high interest rate and are usually backed by certain type of collateral like the inventory or real estate.

Key takeaways

  • A bridge loan is short term loan used until a company or person removes an existing obligation or secures permanent financing.
  • Bridge loans are short term, usually taken up to one year
  • These are usually used in real estate
  • Home owners can use this towards buying a new house while waiting for their present house to sell

How bridge loans work

While applying for a bridge loan, you can except debt-to-income and same credit needs like the mortgage. Most bridge loan lenders won’t go above 80% loan-to-value ratio. As such, you will have to at least avail 20% equity in your present home for a bridge loan to be an option.

Bridge loans are typically used in one of the two ways

  • To pay off the present mortgage, putting any excess toward the new down payment
  • A second mortgage that becomes your down payment for the new home

When to use a bridge loan

In case you find yourself in one of the sticky condition, a bridge loan might keep things over the right direction

  • Sellers in your region won’t accept contingent offers
  • You can’t afford a down payment without proceeding from your present home
  • You’re confident your home will sell but prefer to secure a new home prior to listing it
  • Closing on the present home might be scheduled after closing date for your new home

How to find a bridge loan lender

If we take an example to Mr. Anderson, “instead looking for bridging loan service on web, it is best to consult a professional and trusted credit or bank union in your local market”

He also suggests to stay away from collateral based “hard money lenders who advertise “fast cash” online. They offer bridge loans, but they will charge even high rates than conventional lenders who are not reputed ones.

Benefits and downsides of bridge loans

There are both merits and demerits of using a bridge loan you make transitioning to a new home to run smoothly. In this case, you can consider things like:

Merits

  • You don’t have to move twice

In case you sell your old house prior to closing on the new one, you might require finding some temporary house until you complete the procedures. Here, a bridge loan would simplify the procedure can get you into a new house directly

 

  • You can make a stronger offer

The alternative to use a bridge loan makes a contingent offer on a new home. This means, the offer to purchase is contingent upon you selling your present house. Unfortunately, these offers make a lot of uncertainty for sellers, so they will take offers from another purchaser without the contingency. In case you have a bridge loan, it will help eliminating the contingency altogether.

 

  • Qualifying for a low interest rate

The higher you down payment on a mortgage, the less risk you pose as a borrower. So, you might be qualified for a low interest rate if you render a big down payment. In case your present house is not sold yet, a bridge loan will give you that high down payment and potentially a low interest rate.

Demerits

  • It can be expensive

Between high interest rates and fees, a bridge loan can be more costly than alternatives that also include the home equity loan.

 

  • It is not easy to qualify

If you are not selling your present house yet, you can make two mortgage payments for at least a month or two, and possibly longer. Keeping that as burden, bridge loan lenders will have debt to income and strict credit ratio needs for those who apply.

 

  • You may not get enough

Bridge loan lenders usually offer loans up to a combine loan to value ratio of 80%. This means, you present loan can’t total more of the house fair market value. In case the ratio is above 80%, you might get the money you require, making it an not valuable expense.

Businesses and Bridge Loans

Businesses need bridge loan when they wait for long term financing and require capital to cover expenses. For instance, a company is undergoing a round of equity financing expected to close in 6 months. It may look for bridge loans to render working capital to cover expenses like inventory costs, utilities, rent, and payroll until the round of funding goes through.

Bridge Loans in Real Estate

Bridge loans also show it in real estate industries. In case a buyer has a lag between buying one property and selling another, they may look for bridge loan. Usually, the lenders here offer only real estate loans with low debt to incomes ratio and excellent credit rating. These roll the mortgage of two homes together, rendering the buyer much flexibility as they wait for their old home to be sold.

But, in many times, lenders only offer real estate loans worth 80% of the combined value of the two properties. This means, the borrower should have ample cash saving on hand and significant home equity in original property.

Bridge Loans vs. Traditional Loans

Bridge loans usually have a faster funding process, approval and application process than conventional loans, but, in exchange for this, the loans do have short-term, large origination fees and need fast fees. They pay high interest rates as they know that the loan is short term and they can pay off with low interest, and long term financing immediately. Further, most bridge loans doesn’t have repayment penalties.

What is Bridge Financing?

Bridge financing, often in the form of a bridge loan, is an interim financing option where various entities and companies makes use of it in order to solidify their short term position until a long term financing option is been arranged. This normally comes from a venture capital firm and investment bank in the form of equity or loan investment.

This type of financing bridges the gap within the time when the company’s money is set to run out and when it can expect to receive an infusion of funds. Bridge financing is not widely used to fulfill the company’s short term working capital requirements.

It is also used for initial public offering and includes equity for capital exchange in exchange of a loan.

Key takeaways

  • Bridge financing can take the form of equity or debt and can be used during an initial public offering
  • Bridge loans are usually short term in nature involving high interest rates
  • Equity bridge financing needs giving up a stake in the company instead for financing
  • IPO bridge loan financing is used by companies going public. The financing covers the costs and then is paid when the company goes public

The bottom line

A bridge loan seems attractive, but you should weigh the risks and costs carefully, prior to applying, you might consider certain more options like home equity conversion mortgage, 410(k) loan, personal loan, home equity line of credit, etc. These kinds of loans will help you move out of your current home into the new one, and giving low risk interest and fees related with bridge loans.