Bridge Loans – The Straight Facts
We give you the straight facts on what a bridge loan is, how it works, and whether or not it’s right for you
Bridge loans are most commonly used by investors looking to purchase properties with cash and then flip them quickly. Bridge loans can also be used by home buyers who need to buy a home quickly, or to buy a home before selling their current home.
There are some implications of using a bridge loan that you need to understand. In this guide we will cover what a bridge loan is, how it works, and what questions to ask your lenders.
What is a Bridge loan?
A bridge loan, or a “bridge financing” comes from a private funding source rather than from a bank or credit union.
This type of short-term loan can be helpful when you need money fast, such as when you are purchasing a new property.
These loans come with higher rates because they fund faster than traditional loans and because they are loans based on the collateral rather than on your personal credit or income. This means there is no minimum credit score or income ratio to qualify.
Bridge Loan Examples
Bridge loans are probably best-known among real estate investors as a tool for buying properties quickly. These types of loans are also used by people who are looking to buy a home before their current home sells. Here are some other examples of when bridge loans are most commonly used:
- To purchase a property at an auction
- To renovate a property or make repairs to a property you already own
- To purchase a “fix and flip” property
- To purchase a residential property or a commercial building that will be leased out for income
- To purchase a building that will be occupied by the borrower’s business
- To buy a partner out of a property
- For short-term liquidity for business purpose or for other short-term purpose|
Why would you want a bridge loan?
- Bridge loans can be helpful when you need money fast
- If you want to buy a new home before your current one sells. You must have sufficient equity in your current home in this case.
- You want to purchase an investment property to renovate for resale or turn into a rental unit.
- You want to buy out a partner or family member in a property. You must have sufficient equity in your property for a bridge loan to work in this case.
What types of lenders offer bridge loans?
- Private Money Lenders sometimes referred to as Hard Money Lenders
- Private Mortgage Companies
- Investment Banks
Pros and Cons of Bridge Loans
The Pros
Speed of Funding
You can get this loan from a private money lender MUCH faster than a bank or credit union. These loans are not to be confused with a personal loan or second mortgage.
No Min Credit Score or Income Qualification
You don’t need to have a good credit score to get a bridge loan because this in an asset based loan. Most bridge lenders also do not document your income. However, sometimes a bridge lender may want to see your credit report before approving the loan to look for judgements or liens that may attach to the property.
The Cons Of Bridge Loans
Higher Interest Rates
Bridge loans are risky for the lender, as there is no guarantee that they will be repaid. This is why they carry a higher interest rate than traditional mortgages. Getting stuck in a bridge loan for longer than desired can put a strain on your finances because of the higher interest rate.
Longer than Anticipated Hold Times
In addition to these risks, borrowers may have a difficult time qualifying for traditional mortgage when they want to pay off the bridge loan.
And then if you use a bridge loan to purchase a home before your current home sells, you will be carrying two mortgages. Can you afford both mortgages if your current home takes a long time to sell?
How Can I Buy a Home Before My Current Homes Sells?
The equity in your current house can be used as the down payment and collateral on a new house purchase. It’s similar to a home equity loan except no cash is taken out of the existing home. The lender just uses the equity you have in your old home as the down payment for the new home purchase by putting a lien on your old house until it sells.
Will you have two payments with a bridge loan?
Yes, you will have two mortgage payments if you are using a bridge loan to purchase a new home before you sell your old one. That is, if you have a mortgage on on your current home. You will have your current home mortgage and your bridge loan mortgage until your old home sells.
What’s the advantage of a bridge loan in a seller’s market?
If you are buying a property in a seller’s market and there is no time to wait 30-45 days for traditional financing to fund, a bridge loan may be able to help you buy that property quickly.
A bridge loan has a competitive advantage in a seller’s market because it has faster close times and less requirements for funding. You can also make an offer to purchase with no contingencies when you use a bridge loan to fund it.
How to Write a “Contingency Free” Offer When You Haven’t Yet Sold Your Current Home
Typically a home buyer needs to sell their home first to get approved for a mortgage loan so with an offer to purchase they may include a contingency for selling their current home. In a seller’s market, this type of offer is certain to be rejected.
Bridge loans gives you a competitive advantage by allowing you to purchase a home without selling your home first because you can write an offer to purchase with no contingency for selling your home first. This a very appealing to the seller of a home who might have multiple offers because they are likely to choose the offer which can close fastest.
How do real estate investors use bridge loans as an advantage?
A bridge loan can be used as a form of “cash ” to close quickly on investment properties that are being purchased at a bargain price. Rental property investors, commercial real estate investors, and “fix and flip” real estate investors use bridge loans to purchase properties quickly, very similar to purchasing with all cash.
It can take between 2 weeks to 2 months to secure funding from a traditional bank or credit union. With a bridge loan from a private money lender, it can fund much faster, usually between 1 to 5 days. Because of the speed of funding, bridge loans often mimic cash transactions.
How much can you borrow on a bridge loan?
If you are looking to finance a property using a bridge loan, the amount you can borrow is determined by the “loan to value” limits of the lender. The higher the loan to value ceiling of a lender, the more you can borrow. For example, does your lender lend at 50% loan to value, at 80% loan to value, or somewhere in between? Find out the loan to value limits of your lender, in order to determine how much you can borrow.
How long does it take to get a bridge loan?
bridge loans typically fund much faster than a traditional home mortgage. Bridge financing can take from 24 hours to 2 weeks to fund. But remember, it doesn’t always depend on the speed of the lender, it also depends on the speed of the other parties involved in the transaction who can slow it down.
How Bridge Loans differ from a HELOC or Home Equity Loans
There are a few alternatives to bridge loans. A popular alternative is to use a home equity line of credit (HELOC) as a 2nd mortgage on your home. This will allow you to take out cash equity in your home to use as a down payment to buy another property.
A HELOC is a 2nd position loan that goes in a 2nd lien position behind the 1st mortgage loan on the property.
When you get a HELOC, the lender puts up the money for what you want, and later, you pay off what was borrowed plus interest.
How long can you have a bridge loan for?
This is a question that you need to ask your specific lender, what is the term of the loan? How much time until you have to pay the loan back, in other words. Some lenders only offer a 6 month loan term.
This means that the loan must be paid back in 6 months. But on the other side of the spectrum, there are bridge lenders that offer loan terms of 5 years. In you need 9 months or so to get a bridge loan paid back, a loan term of 6 months is not going to work for you. You’ll want to have a plan for long term financing or permanent financing.
What are the fees associated with Bridge loans
There are loan fees, sometimes called “loan points.” A point is a percentage of the amount borrowed, that is paid to the lender.
There are also miscellaneous fees and closing costs that a lender will charge, these are called “junk fees” and are sometimes labeled as legal fees, processing fees, underwriting fees, review fees, etc.
How much down payment do I need?
Typically, the more money you have for a down payment, the lower your rate. Ask your specific lender about down payment requirements so you are prepared. In the case where a home buyer is using a bridge loan to buy a new home before they sell their current one, if they have equity in their current home, they don’t need a down payment.
Are Bridge Loans Interest Only?
Yes, they are interest only loans. This means that you will not pay towards the principal balance on your bridge loan, but instead your monthly payments will go towards the accrued interest.
What are bridge loan interest rates in 2021?
Bridge loan rates can be at a lower interest rate between 7-10%, or at a high rate between between 12-18%. The final interest rate depends on the quote given to you by each lender.
Ask your specific lender about their criteria for determining the interest rate for your bridge loan.
How do you calculate your monthly payment?
To calculate your monthly loan payment you will need to find out what the loan amount will be. Once you know your loan amount, you multiply it by the interest rate. Then you take that number and divide it by 12 months. For example:
Loan Amount: $175,000
Interest Rate: 10%
$175,000 x 10% = $17,500
$17,500 / 12 months = $1,458.33 is your monthly interest only payment
What happens if you are late with your bridge loan payment?
Just like with any loan, if you are late, the lender will almost always charge a late fee, unless there is an extenuating circumstance. Some lenders will charge excessive late fees, and a higher interest rate, if you are late on your payments.
Look for late payment penalties and default penalties in your promissory note. The promissory note is the loan document that a bridge lender will have you sign at the loan closing.
You need to carefully read the loan documents that the lender is going to have you sign before signing them to make sure you understand what the terms of your bridge loan. That way there are no surprises and you can avoid to pay high interest rates.
Do you need to get Private Mortgage Insurance?
No, you don’t need private mortgage insurance.
How much can you borrow with a bridge loan?
A bridge lender will give you a loan amount as a percentage of the value or a percentage of the purchase price.
Most bridge lenders will lend you a maximum of 65-80% of the value, or purchase price. There are some hard money lenders that will lend at a higher loan to value such as 95%-100% of the purchase price.
The maximum amount that you are allowed to borrow will be determined by the specific lender.
What is an exit strategy for a bridge loan?
The most common exit strategy for a bridge loan is to pay it off with a bank loan, a loan from a credit union or another financial institution. This is a called a “refinance.” When you refinance a bridge loan, you are paying it off with another, longer term loan.
If you are using a bridge loan to buy a new home before your current one sells, your exit strategy for the bridge loan will be to sell your current home.
Depending on the equity you have in your current home, you may be able to pay the bridge loan off in full, or you may need to refinance any balance due with your bank or credit union.
For example: You sell your current home for $500,000. You owe $250,000 on the 1st mortgage. You would pay off the 1st mortgage when your current home sells and have $250,000 in proceeds that you would use to pay off the bridge loan. If there is a balance left on the bridge loan after you pay it down with the $250,000 proceeds, you would refinance that balance with a long term loan from your bank or credit union.
Should you get a Bridge loan?
A bridge loan is an excellent option for those who need alternative sources of funding, particularly for a short period of time.
Contact a bridge lender like us to find out the requirements, the rates and fees, and understand all of the other terms and conditions. Start to build your list of bridge lenders. Should the right situation come along where a bridge loan could be an option, you will be glad to have your list of bridge lenders on hand!
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