What Is a Bridge Loan?
We will start with the basics and explaining what a bridge loan is.
By the definiton, the bridge loan is a type of short-term loan that can provide you with the necessary funding. It’s typically used for purchasing or renovating a real estate property, but besides that, this loan can be used for many other things. In this article, we will discuss what exactly this loan is, how to qualify, as well as pros and cons of it.
Have you ever found yourself in a situation where you need money quickly to finance a certain house project or business venture? If you did, a bridge loan could be the answer.
This type of loan is most commonly used in a time frame called the “ bridging period “ that is referred to a period of buying a new house before selling your old one. This means a borrower wants to buy a new house and needs to act fast, but needs a longer time to sell the old property.
Besides, people usually take this loan so that they can have some funds until their long-term financing can be gained. This kind of loan can also be a good idea for a borrower who has a bad credit score or income issues and cannot obtain other types of financing.
How Does a Bridge Loan Work?
Let’s see how does a bridge loan work, so you’ll have a better understanding if you want and need this particular loan.
If you are in a process of buying a new house but still haven’t sold your old one this type of loan might be just the right one for you. They are usually offered by private lenders but can be obtained through some government-backed programs. The terms of this loan vary depending on the lender you choose but they typically last anywhere from 6 to 36 months. Before applying, you should know that they are structured as interest-only loans. To put it simple, you only pay an interest rate on a loan regularly. Be cautious because it’s a high interest rate, and actual funds you took as a loan are paid in the end of the loan term. This can be a great option if you cannot qualify for a traditional mortgage.
Before choosing a lender, we suggest you do your research and compare offers from different lenders just so you can be sure you are getting the best deal.
How to Qualify for a Bridge Loan?
Even though bridge loans are classified as loans to get for purchasing a new house, they are not just that. This type of loan can be used for your business as well, if you are in a need of relatively quick funding. While bridge loans can be seen as a good way to get the financing you need, you first need to know what are important factors for qualifying.
If you’re a small business owner, you can be eligible to get this loan. While applying you need to take a look at the following
- Solid business plan – Lenders will always choose a borrower with a thought-out plan because they want to be sure you’ll be able to pay it back.
- Personal and business credit score – These types of loans are usually given by private lenders so they will look at this score to determine how likely are you to default this loan.
- Having a collateral – Because these loans take less time to be issued, they also have shorter terms and higher interest rates. Thus, lenders will want you to put down your collateral like a property or some other asset to minimize the risks of giving you a loan.
- High interest rates and fees – Bridge loans have higher interest rates than other types of loans because they are seen as high-risk loans from a lender’s perspective. You should make sure you’ll be able to pay not only this but also other fees that come with them.
Pros and Cons of Bridge Loans
As we already discussed, bridge loans can be a good option if you are in a process of buying a property. Besides this, they are also used for renovations needed in order to flip a house or for other business ventures.
Like any other loan, they come with some pros and cons that you should consider before applying.
Pros
- They are easier to qualify for than a traditional mortgage.
- They have shorter waiting time for getting funds.
- You are able to purchase a new home before selling your current one.
- You can finance your small business without waiting and delays.
- You can start your business venture or help your existing business that is in a need of quick funds.
- You can finance renovations of a new home.
Cons:
- They typically have higher interest rates than traditional mortgages.
- You’ll likely need to put down collateral to minimize the risks for a lender.
- You can end up paying two mortgages if your home does not sell as quickly as you thought.
When Does a Bridge Loan Make Sense?
Even though they have interest rates between 8.5% and 10.5% which makes them more expensive than most long-term financing they can still make a lot of sense to some people.The most popular use of this loan is when people are in a process of buying a new house and haven’t sold their current one yet. If you find a good house on the market, you’ll likely need to act fast in order to secure it and this loan can be perfect because of a short waiting period.
Besides, this type of real estate bridge loan, you can also get the loan in order to help your business. The commercial bridge loan is typically used to expand businesses by buying new properties, office spaces, and equipment while trying to secure more long-term financing.
Bridge loans are normally available for six months to three years periods, although some bridge loan lenders may extend the term to five years. The time frame usually depends on a borrower’s needs and goals. If you are expecting to sell your house within a few months, a yearlong bridge loan would be a good option.
Even with an interest rate being high a borrower can still end up saving money because of a short period of a loan, so there is less interest to be paid in total. Plus, bridge loans can be used to finance repairs or renovations on the new property you buy, which adds value to a property and increases its chances of being sold quickly with a good price.
Alternatives to Bridge Loans
There are a few alternatives to bridge loans that can give you the same type of short-term financing you need.
Business line or credit
Depending on your needs and goals you may be able to apply for a business line or credit from a bank. These funds can be used for a smaller project or emergencies and you don’t even need to put down collateral.
Personal savings or credit cards
Personal savings or credit cards could be also used in these types of an emergency, of course, if you are okay with putting your personal finances at such risk.
Private investors
If you are looking for a bridge loan for your business, you can consider getting needed financing through private investors. Just make sure you prepare solid business plan so an investor can see a potential benefit of investing their money in your business.
Both HELOC and bridge loans can be used to achieve the same effect – to buy a property. So, let’s put bridge loan vs HELOC and see what’s better for you.
HELOC loans are cheaper than bridge loans. A bridge loan is considered a high-risk loan and generally has higher interest rates, plus other fees. HELOC is less risky for a lender and has better interest rates for the borrower. You should take into consideration that for applying for HELOC you need a better credit score. Also, this loan is not meant for anything but buying property.
Final Thoughts
If you’ve ever been in a situation where you need money quickly to finance some venture, this may be the right type of loan for you. It goes without saying that like any other loan you should be careful with taking it out. With this one you need to be especially careful because of the high interest rates.
If you are currently considering applying for this loan, it’s important you first take into consideration a few factors which affect your ability to qualify.
We recommend you talk to your financial advisor and weigh out the pros and cons of this loan to be sure that it is the right one for you and that you’ll be able to pay it back.
