Between February and September 2023, bridge loan transactions increased by 59% over the previous year. Market volatility and rising Fed rates primarily contributed to this trend. Potential homebuyers who apply for bridge loans are on the rise due to the loan’s quick disbursal and shorter repayment periods.
40% of mid-size and 51% of small business owners anticipate a recession in 2024. Stricter lending criteria make securing long-term mortgages difficult in times of economic uncertainty. Lenders might be more risk-averse, making it harder for homebuyers to get approved for conventional loans.
Bridge loans are an effective alternative here, and help ‘bridge’ this financing gap that exists in the market. If you have plans to buy a house now, Houzeo got you covered. We have compiled a list of reputed mortgage lenders below to aid your home-buying journey, so what are you waiting for?
Defining a Bridge Loan
A bridge loan is a short-term financing option primarily used in real estate transactions but not limited to this sector. It provides temporary funds to individuals until they secure permanent financing or settle an existing debt. With a bridge loan, you can secure up to 80% of your home value for 6 to 36 months.
Typically, bridge loans are used to purchase a new house before selling the existing one. Whether a bridge loan is available depends on various factors. This includes the borrower’s creditworthiness, the lender’s policies, the collateral property’s value, and the repayment period.
However, this loan is not intended to replace traditional funding but to be repaid within 1-3 years. This category of loans also carries a higher-than-usual interest rate.
How Does a Bridge Loan Work?
Bridge loans work by letting you cash out equity from a current home and use the same for the down payment of a new house. These loans generally have a shorter time frame of up to 3 years than traditional loans.
Obtaining a conventional loan generally involves due diligence and creditworthiness analysis, among other requirements. This significantly increases the time from application to disbursal of funds. However, during this period, a bridge loan can serve as a strategic financial source to pay off existing debts.
Here are a few points that explain how bridge loans function:
- The period for these loans can be between 6 and 12 months. However, in a few cases, the lender can allow up to three-year periods.
- Interest rates are often higher than usual financing rates, ranging between 9.5% and 12%.
- Some bridge loans, especially when the money needed is high, may require both homes (existing and new) as collateral security.
Bridge Loan Example
It is important to understand how a bridge loan works. Let us understand this with the help of this example:
Current Financial Situation:
- Home Value: $120,000
- Mortgage Balance: $60,000
- New Home Cost: $150,000
- Bridge Loan Amount: $80,000
- Closing Costs: $2,000
Utilizing a Bridge Loan:
- Pay-off Existing Mortgage: $60,000
- Cover Closing Costs: $2,000
- Remaining Balance From Bridge Loan: $18,000
Now, you can use the balance ($18,000) to buy the new house and use the sale proceeds of your existing home to pay the remainder of the loan.
Bridge Loan Requirements
The requirements for a bridge loan vary from those of a conventional loan or financing application. To qualify, an applicant should have at least 20% equity in their current home. This is because lenders allow up to 80% of the loan-to-value ratio.
Further, the applicant must meet the strict criteria related to credit score, credit history, and DTI (debt-to-income ratio). A few lenders require credit scores of 740 and higher, along with a DTI of less than, or up to 50%.
However, these requirements are general and the outcome largely depends on the bridge lender’s terms and conditions. For example, a lender can ease credit score or DTI requirements based on a property’s value or relationship with the applicant.
What Are Some Common Rates for Bridge Loans?
The common bridge loan rates are slightly higher than the usual mortgage rates. They can be between 9.5% and 12%. The rates are based on factors such as asset value, loan terms, creditworthiness, and the applicant’s background.
External factors also influence rates for bridge loans. These include Fed rates, closing costs (2% to 5%), and lending institutions’ cost of capital also impact common rates for bridge loans.
Comparing Bridge Loans and Traditional Loans
As mentioned before, the purpose of bridge financing is not to replace traditional loans. Both concepts are different from each other. Here is a table comparing and contrasting the two financing alternatives:
| Feature | Bridge Loans | Traditional Loans |
| Purpose | Temporary financing until permanent financing is secured or an obligation is paid off | Long-term financing for large purchases or investments |
| Term Length | Short-term (6-12 months, up to 3 years, if the lender permits) | Long-term (typically 15–30 years) |
| Interest Rates | Higher (typically 9.5% to 12%) | Lower (dependent on market rates, generally 3% to 6%) |
| Collateral | Can be both existing and new properties | Typically, the original property |
| Approval Time | Faster approval and disbursal | Slower, due to extensive due diligence and procedures |
| Repayment | Lump sum repayment | Regular monthly payments over the loan term |
Bridge Loans: Benefits and Downsides
Bridge loans have many advantages, which make them quite popular among homeowners. However, they also have a few disadvantages, so over-reliance on this form of financing is not advisable.
Here are a few benefits of bridge loans that make it a popular alternative for people in need of quick financing while buying a new property:
| Advantages | Disadvantages |
| Bridge loans are extremely flexible and can offer tailor-made solutions for rates and repayment terms to applicants. | The interest rates of bridge loans are higher than usual mortgage loans. |
| These loans eliminate the financial gap between purchasing a new property and selling an existing one. | These loans also include shorter repayment periods, which can temporarily increase the financial burden. |
| These loans ensure that the chances of losing a desired property are reduced. | There can be a risk of double payments if the current home doesn’t sell quickly. |
| These are ideal for short-term financing requirements. | A higher interest rate can result in financial strain for the borrower. |
| The approval process is simple, and restrictions are minimal. | There is a higher degree of collateral risk as both properties are often charged. |
How Do I Qualify For a Bridge Loan?
Lenders have a wide range of requirements, which can be extremely different from one another. This is why we always advise applicants to compare offers from various lenders. However, to qualify, you should generally have:
- A good credit score ranging between 680-740
- A debt-to-income (DTI) ratio lower than 50%
- Minimum home equity of 20%
Further, it is also important that borrowers demonstrate their ability to repay the loan. Lenders evaluate this through:
- Proof of income
- Employment history
- A solid repayment plan
Do I Have Alternatives to Bridge Loans?
If you require quick disbursal of funds and do not want to opt for a bridge loan, you can consider other alternatives. Here are the options that applicants prefer most besides bridge loans:
- Home Equity Loans: You can borrow against the equity in your current home, and the interest rates are lower. Usually, the average interest rate for a 10-year loan is around 8.76%, going down to 8.74% for a 15-year loan.
- Home Equity Line of Credit (HELOC): This loan category offers payment flexibility, such as paying interest only on the amount withdrawn and quick disbursal.
- Personal Loan: A personal loan is possible when the amount is not too high, ranging between $1,000 to $50,000.
However, different loan types fulfill different financial requirements. Consider your needs, goals, and financial situation before settling for a loan type, or even a lender.
Bottom Line
A bridge loan provides a strategic alternative to homeowners and businesses that need short-term funding to bridge the gap between two financial transactions. This loan is an excellent tool to finance the purchase of a new property before completing the sale of the old property.
For all the benefits that bridge loans have, they also have limitations. These include quick disbursal of funds and flexible payments, as opposed to high interest rates and collateral requirements, respectively. You should conduct thorough research before you seek funding from bridge loans.
Once you’ve decided that bridge loans are the right option, Houzeo can help you with the rest of the process. Not only have we simplified looking for a home, we have also compiled a list of reputable mortgage lenders near you. So don’t wait, begin your home-buying journey right here!
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Frequently Asked Questions
What is the purpose of a bridging loan?
A bridging loan provides temporary funding to help buyers and sellers bridge the gap between purchasing a new property, selling an existing one, or securing permanent financing.
How does a bridge loan work?
A bridge loan is designed for short-term use, with the loan amount based on the equity in the borrower's current property. Interest rates are higher than conventional mortgages due to increased risk and can be structured as monthly payments or rolled into the loan balance until the term ends.
What are the cons of bridge financing?
Bridge financing typically comes with higher interest rates (unlike other kinds of loans), short repayment periods, and the potential risk of making double payments if your existing property doesn't sell quickly.
