When investing in a new property or home, most people tend to use the money they have secured from selling their previous property. But cases are not ideal every time. Sometimes you have not sold your previous property, but you must buy the new one. Such cases when dates don't align or other mortgage issues linger for a short time, you need a solution.
This short-term borrowing when you want to bridge the financial gap is what we commonly call bridge loans. Bridge loans have their own rules, and there are pros and cons.
What Is a Bridge Loan?
Bridge loans are short-term loans. It is when you want to purchase a new property without selling the previous one, and you lack the funds for its purchase. Usually, the bridge loans are 80% of the cost of the property you are purchasing. It also depends on the seller and how much the seller is willing to lend.
Bridge loans are also known as interim financing, gap financing, or swing loans.
Understanding Bridge Loans and How They Work
Now that we have defined bridge loans, we will explain how they work. Bridge loans have been used between sellers and buyers for a long time, and in many cases, it goes as smoothly, as once you sell your previous mortgage, you pay the loan, but in many other cases, the old debt builds upon the next one and so on.
Applying for bridge loans is like applying for any other loans, and almost all the requirements as also the same. You should have a good credit score, a good debt-to-income ratio, and a clean criminal record.
Some general characteristics which will help you in understating bridge loans and how they work better are as follows:
- Bridge loans can run for 6 months or 12 months, depending on the lender.
- They can be extended if you decide to sell the property to the same lender.
- Usually, the price of the property is the same or 2% above the original price at the time of the loan.
- Most lenders agree on an 80% loan, but again it depends on how much the property is worth and the lender's rules.
Example Of a Bridge Loan
Here is an example that will help you in understanding bridge loans and how they work.
Say, for example, you already own a home worth $200,000, and the one you are looking to buy is for $270,000. The maximum bridge loan amount you can get can be calculated this way, 200,000 + 270,000, which is 470,000. Now you will multiply it by 0.8. The result comes out to be $376,000. This is the amount of bridge loan you can get as per ideal standards.
Bridge Loans Vs. Traditional Loans
When there are traditional loans available, one might wonder why people go for bridge loans.
Here are a few differences on how bridge loans are better than traditional loans and how they are different. To be precise, bridge loans are short-term. You can borrow a lot more money. But as compared to traditional loans, they have more interest rates on them, and you must return them earlier as compared to traditional loans.
Though the process is the same, there are some rules which make some people prefer bridge loans and others don't.
How To Repay Bridge Loans?
We have talked about all other aspects; now, it comes to repaying the loan. It is returned the same as the other loans, but the interest rate is definitely higher.
The usual repay time is 12 months and even less, depending on the loan amount. You can repay it from the money from selling the previous mortgage. Most people go for this option because it is the main reason in the first place. You can make payments in installments, or go for a balloon payment.
Pros And Cons of Bridge Loans
Understanding bridge loans and how they work has now been explained, but there are several pros and cons of a bridge loan. Let’s look at them briefly.
Pros
- You can buy any new home or property even when you are holding a loan for another.
- You don't have to start payments the next month. There will be a few months free of any payments.
- You can remove the contingency from the agreement and even buy a new home, but it is subjective to some specific cases.
Cons
- A bridge loan has more interest than a traditional loan, so it can be expensive.
- There are certain qualifications to own two homes.
- When you have two properties at one time, handling both of them can be hard and quite stressful.
Average Fees for Bridge Loans
The fee for a bridge loan varies, and it can fluctuate depending on the conditions. If we take the ideal example and what it is right now, the administration fee for bridge loans is 8.5%, and then the appraisal fee is 4.75% on every $10,000. There is also a loan origination fee on them, which is 1% of the total amount. Every lender does not charge the origination fee.
Bridge loans can fill the gap between buying a house and selling the one you have, so it makes a great alternative to a traditional loan for many people. It is often the best solution.
References:
Investopedia
Credit Karma
The Balance
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