What exactly is a bridge loan and what can
it do for you? A bridge loan is simply a short-term loan used by a person
or business that needs a fast cash infusion until permanent financing can
be achieved. A bridge loan, sometimes referred to as a swing loan or gap
financing, is generally expected to be paid back very quickly. Most bridge
loans have a term of about six months to one year.
When would someone need a bridge loan? Bridge loans are often used by
prospective home buyers who are ready to buy, but who have not yet sold
their current home. When the housing market is booming and houses are
selling within days or weeks of being listed, a bridge loan makes little
sense. But what about those times when the housing market seems to be
moving along at a more reasonable pace?
Imagine, for example, that you find your dream home. You are eager to
purchase it, except for one major setback: you need to sell your current
home first. In the meantime, you can snatch up that dream house by
applying for a bridge loan. A bridge loan can allow you to pay off the
mortgage on your current house, or gather enough cash to make a down
payment on your dream house while you wait for your current home to sell.
In hindsight, the opposite situation would be ideal: selling your home,
and then finding your dream home. But since life, and especially issues of
personal finance, are not always ideal, a bridge loan is a viable option
for anyone who finds themselves caught in between.
The terms of a bridge loan can vary widely. Some types of bridge loans
allow you to completely pay off the mortgage on your current home. A
fairly typical bridge loan might work as follows: the bridge loan is used
to pay off the mortgage on your current home, and the rest of the money is
used to make a down payment on your new home. In this type of scenario,
closing costs and six months of prepaid interest are normally subtracted
from the loan amount. If the first home is not sold after a period of six
months, the borrower is usually allowed to begin making interest-only
payments on the bridge loan. When the first home is sold, the bridge loan
can be paid off in its entirety, with any unearned interest payments
credited to the borrower.
Be warned that using bridge loans in this way—to span the disparity
between two separate transactions—can be costly. Bridge loans often come
with high fees, so make sure you understand the terms of your loan before
signing. Also, be prepared to face the possibility of having to pay the
equivalent to three mortgage payments (your current house, new house, and
the amount of the loan itself) until your home is sold. Before even
considering a bridge loan, speak to your real estate agent. Find out how
long homes in your houses’ price range are taking to sell. If the housing
market is so slow that you expect your home to remain unsold for many
months, a bridge loan may not be such a good idea.
Bridge loans are also commonly used in real estate investing. Individuals
interested in investing in real estate property, but who may not have
access to conventional loans, can use a bridge loan to make the purchase.
Individuals who use bridge loans may be unable to qualify for conventional
loans due to credit problems. Thus, many bridge loans are often available
through non-traditional lenders, who offer interest rates ranging from 14
to 20 percent. These lenders often also charge ‘points’, or fees, on these
loans. One point is one percent of the total loan amount. Because these
lenders are not as concerned with credit ratings as traditional lenders,
bridge loans are much more accessible, though also much costly.
Bridge loans offer a fast and relatively easy way to receive a fast cash
infusion. But they are also saddled with higher than average fees and
interest rates. The best advice regarding bridge loans is also perhaps the
simplest: don’t use them unless you really have to.
