A bridge loan, also known as a swing loan or gap financing, is a short-term loan that is used to bridge the gap between the purchase of a new property and the sale of an existing property. The loan is typically secured by the existing property and is used to provide the borrower with the funds needed to purchase the new property before the existing property is sold.
How does a bridge loan work?
A bridge loan works by providing the borrower with the funds needed to purchase a new property before the existing property is sold. The loan is typically secured by the existing property and is typically for a shorter term than a traditional mortgage. The borrower will then use the proceeds from the sale of the existing property to pay off the bridge loan.
For example, let’s say a borrower wants to purchase a new home for $500,000, but their current home which had 400,000 in equity has not yet sold. They are able to secure a bridge loan for $250,000, which they use as a down payment on the new home. Once the current home sells for $450,000, the borrower uses the proceeds to pay off the bridge loan.
Pros and cons of bridge loans
Pros of bridge loans include:
- They allow borrowers to purchase a new property before the existing property is sold
- They can provide a quick and easy solution for borrowers who need to move quickly
- They can be a good option for borrowers with a strong credit history
Cons of bridge loans include:
- They typically have higher interest rates than traditional mortgages
- They can be risky, as the borrower is relying on the sale of the existing property to pay off the loan
- They typically have shorter terms, so the borrower will need to pay off the loan quickly
Typical bridge loan costs
Bridge loans come with costs that are different from conventional loans. The interest rates on bridge loans are typically higher, sometimes as much as 2% above prime rate. Additionally, borrowers will also be required to pay closing costs which can be as high as several thousand dollars. These costs also include an origination fee, which is a fee charged by the lender for processing and underwriting the loan.
Bridge loan alternatives
There are several alternatives to bridge loans, including:
- A home equity loan, which allows the borrower to use the equity in their existing property as collateral for a loan
- A cash-out refinance, which allows the borrower to refinance their existing mortgage and take out cash to use as a down payment on a new property
- A second mortgage, which allows the borrower to take out a separate loan in addition to their existing mortgage
How to get a bridge loan to buy a house
To get a bridge loan to buy a house, the borrower will need to meet certain qualifications set by the lender. This may include having a good credit score, a steady income, debt-to-income ratio, and enough equity in the existing property to secure the loan. The borrower will also need to provide documentation such as proof of income, proof of property ownership, and an estimate of the sale price of the existing property.
When you should consider a bridge loan
A bridge loan may be a good option for borrowers who need to purchase a new property before the existing property is sold. This may include individuals or families who need to move quickly due to a job change or other circumstances. It is also useful for borrowers who have a strong credit history, and enough equity in the existing property to secure the loan.
FAQ
What are the risks of a bridge loan?
The risks of a bridge loan include the possibility that the existing property may not sell as quickly as anticipated, leaving the borrower with two mortgage payments. This can be costly and may make it difficult for the borrower to pay off the bridge loan.
Is a bridge loan expensive?
Bridge loans are more expensive than traditional mortgages due to their higher interest rates and short-term nature. Additionally, the borrower may also be required to pay closing costs and other fees associated with the loan.
Is bridge financing hard to get?
Bridge financing can be harder to get than traditional mortgages, as they are considered a higher risk for the lender. Borrowers will need to meet certain qualifications, such as having a good credit score, a steady income, and enough equity in the existing property to secure the loan.
How many months is a bridge loan?
Bridge loans are typically for a shorter term than traditional mortgages, typically 6-12 months. This is because the loan is meant to bridge the gap between the purchase of a new property and the sale of the existing property.
How much can I get on a bridging loan?
For a bridge loan, you will typically need to have a minimum of 20% equity in your current home. This means you can borrow a maximum of 80% of your loan-to-value ratio (LTV). The LTV ratio is a comparison of the value of the property to the amount of the loan, it’s a way for the lender to determine the risk of the loan. In the case of a bridge loan, the lender will use the value of your current home as collateral for the loan. This equity in your current home acts as a security for the lender and makes the loan less risky. Borrowers will also need to meet certain qualifications such as a good credit score and steady income.
How are bridging loans paid back?
Bridge loans are typically paid back when the existing property is sold. The proceeds from the sale of the property are used to pay off the bridge loan. In some cases, the borrower may also be able to refinance the bridge loan into a traditional mortgage after the existing property is sold.
