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.
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