Bridge loans enable homebuyers to borrow money against their existing residence in order to cover the down payment on a new residence. If your goal is to buy a new house before your old one sells, a bridge loan can be a smart choice for you. Also, companies who need to pay running costs while awaiting long-term capital can find this type of financing useful.
A bridge loan for real estate needs the borrower to put up their present property or other assets as security for the debt, and they also need to have at least 20% equity in that residence. Bridge loans are appropriate for borrowers who anticipate a rapid sale of their present property because they frequently have high interest rates and only last for six months to a year.
How Do Bridge Loans Work?
A bridge loan is a type of short-term financing that enables people and organizations to borrow money on a flexible schedule for up to a year. Bridge loans, also known as bridging financing, interim financing, gap financing, and swing loans, are backed by property like the borrower’s house or other assets. Bridge loans are more expensive than conventional, long-term financing solutions because they often carry interest rates between 8.5 and 10.5 percent.
Yet, compared to conventional loans, the application and underwriting processes for bridge loans are typically quicker. Also, if you have the necessary equity in your primary residence, you can likely qualify for a bridge loan if you can qualify for a mortgage to buy a new property. Due to this, bridge loans are a well-liked choice for homeowners who need quick access to money to buy a new home before they have sold their existing one.
How Bridge Loans Operate
It can be challenging to first obtain a contract to sell the property and then close on a new one within the same period when a homeowner decides to sell their present home and buy a new one. Also, a homeowner might not be allowed to purchase a second property without first getting the proceeds from the sale of their primary residence. To pay for the down payment on their new property in this situation, the homeowner may take out a bridge loan on their existing home.
In this case, a homeowner can work with their current mortgage lender to secure a brief loan of six to twelve months in order to “bridge the gap” between the sale of their old house and the purchase of a new one.
Bridge loans aren’t always made by traditional mortgage lenders, but they’re more frequently provided by online lenders. While being secured by the borrower’s residence, bridge loans frequently carry higher interest rates than other types of financing, such as home equity lines of credit, due to their brief loan terms.
The bridge loan can be paid off if the borrower sells their primary residence, leaving them with only the mortgage on their new home. However, the borrower will be liable for making payments on their first mortgage, the mortgage on the new property, and the bridge loan if their house does not sell within the limited loan term. For homeowners who aren’t likely to sell their house in a short period of time, bridging loans are a risky option.
Uses for Bridge Loans
When a homeowner wishes to purchase a new home while selling their current one, bridge loans are most frequently used. A borrower may utilize a percentage of their bridge loan to settle their existing mortgage and use the remaining sum as a down payment on a new house. The down payment for a new home can also be covered by a bridge loan used as a second mortgage by a homeowner.
Expenses of Bridge Loans
If you wish to purchase a new home or other real estate but haven’t yet sold your current property, bridge loans are an easy method to get interim financing. However, the cost of this financing is often more than the cost of a conventional mortgage.
Depending on your creditworthiness and the loan amount, bridge loan interest rates typically vary from the prime rate—currently 3.25%—to 8.5% or 10.5%. Business bridge loans have significantly higher interest rates, which typically run from 15% to 24%.
Borrowers shall pay closing costs, additional administrative and legal fees, and interest on the Bridge Loan. For a bridge loan, closing charges and fees may range from 1.5% to 3% of the entire loan amount and could include:
- Assessment charge
- Fee for administration
- Escrow charge
- Cost of a title policy
- Notarial fees
- Origination charge for loans
- Different Bridge Loans
Bridge loan variations are frequently caused by the vast variety of conditions that lenders offer depending on the borrower’s creditworthiness and financial requirements. Hence, even if bridge loans aren’t always categorized into specific sorts, they frequently differ in terms of interest rate, manner of repayment, and loan period.
There are various ways to handle interest repayment on bridge loans. Some might prefer lump-sum interest payments that are paid at the end of the loan period or are deducted from the total loan amount at closing, although some lenders demand borrowers to make monthly installments.
Think about a homeowner who wants to borrow $25,000 to finance the down payment on a new house but hasn’t yet sold their present one. Lender A provides a $25,000 interest-only bridge loan with a 5% interest rate for a period of six months.
As part of this repayment arrangement, the borrower is required to make interest payments of around $104 per month ($25,000 loan principle x 0.05 interest / 12 months). The money earned from the sale of the borrower’s current house will be used to pay off the loan’s initial balance.
On the other side, Lender B provides a $25,000 fully amortized bridge loan at the same interest rate. Here, the revenues from the sale of the borrower’s prior property are theirs to keep. Yet, their payments will total around $2,140 because they will cover both principal and interest.
If you have any questions or concerns regarding bridge loans and their associated interest rates, please don’t hesitate to reach out to our friendly and professional staff at Fairfax Mortgage Investments today for further details and to explore your options.