What Are the Pros and Cons of Bridge Loans?
Bridge loans can be incredible depending on your situation! Dive into this article to learn all about the pros and cons of bridge loans.
During the first 4 months of 2019, about 673,000 homes were sold, which is a 12.4% increase from last year.
The same source tells us that by 2020, the real estate industry will account for over 20% of commercial drone use.
Both commercial and residential sales are on the rise. But buying and selling aren’t always cut and dry. Many homeowners face a two-step transaction of buying a new building while trying to sell an old one.
In 2018, almost 90% of repeat buyers also sold or planned to sell their previous homes.
If you have to buy before you sell, you might need to take out a short-term loan. So what are the pros and cons of bridge loans?
Bridge loans can be an excellent means for getting you into your new home or commercial space so that you can focus on selling your old one.
Here’s a guide that will lay out the pros and cons of bridge loans.
What Is a Bridge Loan?
One type of short-term loan is called a bridge loan. Bridge loans can be set up for anywhere from a couple of weeks to a couple of years. Typically, they don’t go beyond 6 months.
A hot market makes things difficult for someone who’s looking to buy and sell at the same time. If you sell your home before you buy another, you could end up homeless. But if you wait too long, you could end up having to fork over monthly cash for 2 mortgages.
A bridge loan provides a bridge to help you over that difficult in-between time. It allows for the loanee to meet their current financial obligations by providing immediate cash flow.
Bridge loans are usually backed by some form of collateral, like the real estate you’re looking to sell or inventory that’s waiting to fill up your new commercial spot.
A bridge loan is also referred to as a “bridging loan,” “bridge financing,” or a “swing loan.”
It isn’t uncommon for these types of loans to require 20% equity, and they generally have higher interest rates.
But if you’ll have your funds to pay back your bridge loan within a short period of time, a bridge loan is an excellent way to fund your purchase in the meantime.
How Do They Work?
Bridge loans vary. Depending on who your lender is, the terms, costs, and conditions can vary from lender to lender.
Some are set up to ultimately pay off the old home’s first mortgage at the closing. On the contrary, some pile the new debt on top of the former.
Some bridge loans carry monthly payments, whereas others require upfront or end of term lump sum interest payments.
Bridge loans are similar in many ways, such as:
- They usually run for around 6 months
- Typically, they’re secured by the buyer’s home
- They all have interest
- They rarely extend terms
Often, you must have equity to qualify for a bridge loan. For example, say you have a $600,000 home with $400,000 on the mortgage. That means you’d have $200,000 in equity.
Typically, the most significant bridge loan you can get is about 80 percent of your equity, so that means you’d be able to put $160,000 towards a down payment on your new home.
Bridge Loan vs. Home Equity Loan
One of the most popular alternatives to bridge loans is home equity loans.
Just like a bridge loan, home equity loans are secured loans that use your current home as collateral. Other than that, they’re very different.
Home equity loans are long-term loans, and repayment periods are anywhere from 5 to 20 years. If you qualify for a home equity loan, interest rates are usually lower.
But they’re a little riskier because if your old home fails to sell, you could end up paying 3 loans: your new mortgage, your original mortgage, and your home equity loan.
If you’ve built up a lot of equity in your current home, a home equity loan is a safer option.
What Are the Pros for Getting a Bridge Loan?
There are a few reliable pros for opting to get a bridge loan. If you’re looking to get some quick cash for purchase before you sell your old abode, bridge loans are an excellent way to enable you to do so.
When you use a bridge loan for a real estate purchase, you can immediately use the equity on your existing house to buy that new home. That means you can put your current home on the market, without having to wait until it sells.
Often, bridge loans don’t have to require monthly payments for the first few months, which offers flexibility to the homeowner to pay when they have the cash flow (after their old home sells).
You can make an offer on the house you want to purchase without a sale contingency.
When Would Someone Need a Bridge Loan?
Not everyone should take out a bridge loan. But for some individuals, it’s the perfect means for being able to buy the home of their dreams. Some of the reasons why someone might need a bridge loan are:
- You can’t afford a down payment on a new home without the proceeds from your old one
- You’re confident your current home will sell, but you’d rather secure a new one before listing it
- In your area, sellers won’t accept contingent offers
- Closing on your existing home is scheduled for AFTER the closing date of your new one
Now let’s take a look at some of the cons of getting a bridge loan.
What Are the Cons for Getting a Bridge Loan?
There are a few cons of getting a bridge loan, but if you’re the right candidate, the benefits outweigh any potential negatives.
Some of the potential cons for getting a bridge loan are:
- You might have to pay for an appraisal
- You’ll have closing costs and fees
- You may own 2 homes, with 2 mortgage payments, for a short period of time
- You’re limited to 80% LTV (loan-to-value ratio), which requires more than 20% equity in order to yield enough money for your new home
- You’ll pay high-interest rates
- Your lender may use a variable prime rate that increases over time
- They’re more expensive than a home equity loan
In addition, the stress of handling 2 mortgages plus the bridge loan interest is too much pressure for some people.
But if you’re confident your current home will sell within a few months, bridge loans are an excellent way to help you get our of your old home and into your new one, without having to worry about that awkward in-between period.
Find the Right Lender
One tip for using a real estate bridge loan is to make sure you partner with the right lender.
Banks rarely offer mortgage bridge loans – they are more of a niche product.
There is a great deal of flexibility in what different lenders offer. Not all lenders require a minimum FICO score or a set-in-stone debt to income ratio.
The best advice you can get is to shop around. Start locally as it’s always better to work with a lender who’s local. Ask people who have used bridge loans before or look for testimonials. Any reputable lender should have reviews that speak to their services.
Make sure you ask about terms and fees. And if you aren’t sure how long it’ll take for your old home to sell, ask your potential lender if they offer extensions.
Compare rates and terms so that you don’t jump into an agreement with anyone too quickly. While you might be anxious to nail down a loan quickly for the short-term, the best rate will only help you in the long-term.
Take your time in finding a lender that is reputable, professional, easy to communicate with, and offers terms that work for you and your situation.
The Pros and Cons of Bridge Loans Vary
One of the cons to bridge loans is that they are short term, with high-interest rates. But if you’re expecting your old home to sell in within a few months after listing it, a bridge loan is the perfect option.
Plus, there are so many different terms. If you’re worried about those first few months, opt for a bridge loan that doesn’t require any monthly payments in that first couple of months.
Just like any loan, there are pros and cons of bridge loans. But depending on our situation, the pros should outweigh the cons.