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What Are The Pros and Cons of Bridge Loans?

Residential bridge loans can help homeowners bridge the financial gap between selling and buying a house. When you sell a property, bridge loans for home purchases can provide a short-term cash boost while you’re waiting to close the sale on your old home. While people frequently use bridge loans for down payments on a new property, these financing options also have additional applications.

In this post, we’ll outline the pros and cons of bridge loans, discuss how to get a bridge loan, and answer the question, ‘what is a bridge loan mortgage?’.

What is a Bridge Loan?

A bridge loan is a short-term loan designed to provide financial assistance for immediate cash flow needs during the period between the demand for cash and its availability. For example, if standard bank financing is unavailable to you, you can access bridge loans to buy a house while your old home is on the market.

Bridge loans timelines can be set for anywhere between a couple of weeks and a few years. However, they are typically used for less than six months. Bridge loans offer people a financial cushion to help them through a challenging interim period when they must meet their current financial obligations with immediate cash flow.

Generally, bridge loans are backed with collateral, such as the property you are trying to sell or the inventory filling your new commercial spot. Bridge loans are also known as ‘swing loans,’ ‘bridge financing,’ and ‘bridging loans.’

Bridge loans have specific requirements that can be debilitating to some homeowners. They typically require up to 20% equity and can have significant interest rates. However, if you can quickly sell your home and repay your bridging loan, you won’t pay much interest. You may find they provide an efficient way to fund your purchase in the meantime.

How Do Bridge Loans Work

Bridge loans typically have the same requirements as a standard mortgage. For example, when you use a bridging loan for a property purchase, you’ll need to place some equity in the property you’re using as collateral. Let’s imagine that your home is worth $400,000 but still has $200,000 left on the mortgage; you would have $200,000 in equity. A bridging loan must be backed by collateral, so you must have access to equity.

In general, bridging loan terms last between 6-12 months until you have to start paying back the loan. Remember, these loans are designed to be used on a short-term basis to help you during a transitional period.

Bear in mind that most lenders that can offer you a bridge loan won’t exceed a loan-to-value ratio of 70%. This means you’ll be required to maintain at least 30% equity in the current asset that you own if you want to access a bridge loan.

Pros and Cons of Bridge Loans

There are multiple pros and cons of bridge loans, including:

Pros

Bridge loans can be a great source of temporary funds while waiting for a contingency to occur and want to proceed with a purchase before it’s completed. For instance, as a homeowner, you can obtain this short-term loan until your house sells if you wish to make an offer or put a payment down on a new home. Bridge loans help fill this gap in time between selling one property and purchasing another.

Most of the time, a buyer needs the down payment from selling their previous home to purchase their new one. The most significant benefit of bridge loans is that they allow buyers to be competitive, even though their down payment is tied to another property.

Cons

Bridge loans typically have high transaction costs and interest rates. They are designed as temporary financial sources, so they come with significant interest rates to incentivize you to pay off your loan quickly. These high rates can be risky if your property doesn’t sell as planned.

Lenders also have substantial transaction costs with bridging loans. The borrower is in a bind to free up money because they are equity rich but cash poor.

The biggest disadvantage of bridging loans is when a borrower uses the loan to buy a new property and fails to sell their old home, essentially falling deeper into debt.

Qualifying for a Bridge Loan

When you’ve applied for a bridge loan, lenders will consider fundamentals such as credit history, loan-to-value, and debt-to-income ratios. Primarily, you’ll have to have substantial equity in your current home. You’re able to borrow up to 80% of your home value, so you will only receive a substantial loan if you have made a significant dent in the principal or your home value has appreciated since you purchased it.

Secure Financial Funding Today

If you cannot qualify for a bridge loan, we provide access to a wealth of funding options to help you survive between a property sale and purchase. Contact us today to see which of our merchant funding solutions are right for you. Or if you are in need of a commercial bridge loan we can also assist.