If you’ve never heard of a bridge loan, you’re not alone! While the bridge loan is not the most popular, and definitely not the sexiest of all the loans, it does serve a purpose.
In this article, I’ll explain what a bridge loan is, how you can use it, as well as some of the benefits and drawbacks associated with it. Then you can decide if a bridge loan is a useful option for you.
Okay, let’s dive in!
What are bridge loans and what can they be used for?
A bridge loan is a short-term loan that is used to provide financing to a person or company during a period of transition. In other words, a bridge loan is there to help you “bridge” the financial gap for a short period of time (usually up to one year).
Bridge loans are commonly used in real estate and allow you to use the current equity (value of home minus remaining mortgage) of your home to borrow money.
As an example, let’s say you land an awesome new job, but in order to take it, you have to relocate. So, you put your home up for sale and, while you’re anxiously waiting for a buyer, you find the perfect home in your new city. You want to buy a new house but you won’t have enough money for a downpayment until your current home sells.
Enter the bridge loan.
A bridge loan can provide you with the money you need now so that you can buy a new home before you sell your current one.
Companies can also use bridge loans to help cover certain costs while they wait for more long-term funding.
Do you qualify for a bridge loan?
Once you find a lender that offers bridge loans (more on that below), you will then need to see if you qualify for a bridge loan. According to LendingTree, in order to qualify, you will need to satisfy the following criteria:
- How’s your credit? Lenders will want to see a good-to-excellent credit rating.
- Do you have enough equity in your home? You need to have at least 20% equity in your current home.
- What’s the housing market like where you live? Lenders will look at the housing market in your area to try and assess if your current house is likely to sell quickly or sit for an extended period. If the market is stale, a bridge loan might not be the right solution.
- Can you afford it? Lenders will use different financial metrics to decide if you can afford to take on a bridge loan. Like I talked about before, they will look at things like your debt-to-income ratio.
Who should use bridge loans?
There are definitely benefits and downsides to bridge loans (more on that later). However, a bridge loan might be an option for you if you meet some of these criteria:
You need money fast
If you’re in a situation where you’ve found your dream home and put in an offer but the seller won’t accept a contingent offer (the contingency being that you have to sell your home before you can purchase theirs), then you might consider a bridge loan. You can use the money you obtain with a bridge loan to make a downpayment on your dream home and secure the sale, while you wait for your current house to sell.
You expect your current home to sell quickly
If you’re in an area where homes sell quickly then you might be well-positioned for a bridge loan. This is because bridge loans are meant for the short term. So, the quicker your house sells, the sooner you’ll have the money you need to pay back your loan.
You don’t want to sell your home until you’ve purchased a new one
Maybe you’re afraid that your home will sell super fast – before you’ve found a new place to live. This could result in you having to find temporary housing, and that can get expensive. If you want to secure the purchase of a new home before you sell your current home, then a bridge loan is a financial tool that can help you to achieve this.
You can financially handle it
Are you even eligible for a bridge loan? There are certain metrics that you will generally have to meet like having a low debt-to-income ratio. What is a low income to debt ratio? It’s a comparison of how much of your income is going to debt repay off each month for things like your mortgage, car payments, or credit card payments.
You’ll be more eligible for a loan if you have a low debt-to-income ratio this signifies to lenders that you can manage your money. They can see that you have enough money to pay your bills (or pay back loans), and that makes you an attractive borrower.
To get a sense of what your debt-to-income ratio is, you can use MU30’s calculator below:
Who shouldn’t use bridge loans?
While some people are well-positioned to take on a bridge loan, there are others who are not. This can be based on a number of scenarios including some of the following.
You anticipate your current home will take a long time to sell
Bridge loans are short term loans. Usually, you have to pay them back within the term of a year. If you think it’s going to take months or years to sell your home, then this is not a good choice for you.
You don’t want to deal with two mortgages
There is nothing more adult than having a mortgage. And, honestly, having to pay a mortgage kind of sucks. Having to pay two mortgages would suck even more. If you’re not interested in managing two mortgages at once, then maybe no bridge loan for you!
You are a high-stress individual
I am a high-stress individual. I worry about all of the things. If I knew I had a loan to pay back in a short period of time and there was no guarantee that I would have the money I needed to pay it back in time…this would definitely keep me up at night. So, based on this criteria, I would not be a good candidate for a bridge loan.
How do you get a bridge loan?
If you think a bridge loan is a good fit for you and your current situation, where do you go to get one?
Not every lender will offer a bridge loan on their menu of financial items as they are somewhat of a specialty item. Below are some of the places that are likely to offer a bridge loan option.
You can start by reaching out to your current local bank or credit union to see if they offer bridge loans. Your local bank is a good option because you have history with them and, because they are local, they will be aware of what is going on with your local real estate market.
Hard money lenders
Hard money lenders are private mortgage lenders (meaning an individual or company – not a bank) who lend their money to those who need it. Be aware of hard money lenders as they tend to charge some of the highest interest rates. Loans from a hard money lender have been referred to as “last resort loans” due in part to the high rates.
If you need help finding a bridge loan you can also reach out to a mortgage broker to see if they can assist you in your search. They should also be able to answer any questions that you might have in regards to whether a bridge loan is right for you.
What are the benefits of bridge loans?
- Quick application, approval, and funding process – The process of getting a bridge loan is often faster than securing other types of loans.
- No home sale contingency – Your offer might be more appealing to a seller if there is no home sale contingency. Many people include this contingency which basically means that they will only go through with the purchase of the home if they can sell their own home within a certain period of time.
- No expensive, intermediate accommodations – A bridge loan means you don’t have to shack up in a rental or a hotel if your home sells before you find a new place to live.
What are the downsides of bridge loans?
- You pay a high fee for convenience – Because bridge loans are generally short-term (to be paid back within a year or less), lenders charge more for interest to ensure that it’s worth it for them. There are also origination fees associated with closing costs so make sure you know the cost of everything involved before you commit.
- Having to pay for multiple mortgages – When you take out a bridge loan to purchase a new home prior to the sale of your current home, you will be paying two mortgages. This isn’t an ideal situation.
- Require a strong financial situation – In order to be eligible for a bridge loan, you have to be in a pretty secure financial position. If you have a ton of debt or a terrible credit score, then you might not even qualify for a bridge loan. You also need to have considerable equity in your home (min of 20% equity).
Alternatives a to bridge loan
If you feel like a bridge loan isn’t the right fit for you, there are some alternatives that you can look into.
A home equity line of credit (HELOC), is one alternative you can look into. Similar to a bridge loan, a HELOC allows you to borrow against the equity in your home. However, there are a lot of differences between the two. While a bridge loan is relatively fast and easy to obtain, it generally takes longer to get a HELOC and it can be a more intense approval process. However, a HELCO generally comes with lower rates and fees. And, while a bridge loan is a short-term loan, a HELOC gives you more time to pay it back.
Another difference is that many banks will not provide HELOCs on real estate that is currently listed for sale. So you have your house up for sale and you’re looking to fund a new real estate purchase, then a HELOC likely won’t work for you.
To find out if a HELOC is right for you, check out Figure, a company that makes getting a HELOC extremely easy. They process their loans in days, rather than weeks or months, making them a perfect choice for those who are in a time-crunch.
Home equity loan
You can look into a home equity loan. Once again, this is a loan that allows you to borrow against the current equity of your home. A home equity loan allows you to take out a fixed amount of money that you repay in equal monthly payments over a predetermined amount of time – similar to a normal mortgage.
The benefit of a home equity loan over a bridge loan is that it often comes with a lower interest rate and fees. However, it can be more difficult to qualify for these loans as they are largely based on your credit history and other financial factors.
A bridge loan is another tool that you can put in your financial tool belt. It’s up to you to decide if this tool is right for you and this will depend on a number of factors including the strength of your financial situation, your ability to deal with stress, and the state of your local housing market.
While a bridge loan can help you achieve your real estate dreams remember that it comes at a cost. With high-interest payments and a short amount of time to repay your loan, you want to make sure that you aren’t putting yourself in a precarious financial situation.
¹ Figure’s APRs can be as low as 2.99% for the most qualified applicants and will be higher for other applicants, depending on credit profile and the state where the property is located. For example, for a borrower with a CLTV of 45% and a credit score of 800 who is eligible for and chooses to pay a 4.99% origination fee in exchange for a reduced APR, a five-year Figure Home Equity Line with an initial draw amount of $50,000 would have a fixed annual percentage rate (APR) of 2.99%. The total loan amount would be $52,495. Your actual rate will depend on many factors such as your credit, combined loan to value ratio, loan term, occupancy status, and whether you are eligible for and choose to pay an origination fee in exchange for a lower rate. Payment of origination fees in exchange for a reduced APR is not available in all states. In addition to paying the origination fee in exchange for a reduced rate, the advertised rates include a combined discount of 0.75% for opting into a credit union membership (0.50%) and enrolling in autopay (0.25%). APRs for home equity lines of credit do not include costs other than interest. Property insurance is required as a condition of the loan and flood insurance may be required if your property is located in a flood zone.