pros and cons of bridge loans

The Pros and Cons of Bridge Loans

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Date Posted:

April 12, 2024

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It should come as no surprise that the most significant concern today for home buyers is affordability. Inflation has caused rising home prices, and many feel that owning a home is untenable, and mortgage interest rates seem high.

However, various financing and refinancing options are available to help current homeowners and first-time buyers overcome economic difficulties to secure a home. A bridge loan is one such option.

Let’s dive into the pros and cons of bridge loans to see what they’re all about!

What Is a Bridge Loan?

A bridge loan is a short-term loan that provides homeowners with financing during a transitionary period. Also called a hard money loan or swing loan, you can use this short-term financing option when moving from one home to another.

Bridge loans are beneficial when you’re in a pinch and need to move quickly.

The loan amount can range from several thousand to over one million dollars. Because they are available in higher amounts, commercial real estate developers and investors may also use bridge loans if they face a cash flow shortage.

How Does a Bridge Loan Work?

Bridge loans can work in a variety of ways because they vary in the following:

  • Conditions
  • Cost
  • Structure

For instance, you could use a bridge loan to cash out equity from your current home as a down payment on a new house. You could also use your old home and new home together as collateral for a bridge loan to help secure a bigger mortgage.

Although bridge loans vary drastically, there are some standard features:

  • 6- or 12-month term secured by the borrower’s current home
  • An interest rate ranging from the prime rate to the prime rate plus two percentage points

Additionally, bridge loans often have more forgiving qualification requirements than traditional loans.

For example, while creditworthiness is essential when exploring this financing option, bridge loan lenders have more underwriting flexibility, so some NMLS-licensed lenders accept a credit score as low as 500. Of course, good credit will get you a more favorable interest rate, but these loans are within reach for most buyers.

Additionally, some lenders will extend a bridge loan to borrowers with a debt-to-income ratio (DTI) of as high as 50%. Traditional mortgage lenders prefer a DTI ratio of 28-35%.

The Pros of Bridge Loans

There are several benefits of bridge loans to consider. Below, we explore the top three.

Quick Cash

Bridge financing is best for time-sensitive and quick real estate transactions. Some lenders can close in as fast as two weeks.

Payment Flexibility

Bridge loans allow homeowners to defer their monthly payments until their current property sells. The option to make interest-only payments is also available.

Further, most bridge loans have no prepayment penalty. So, if you pay the loan off earlier than expected, you won’t face a fine.

No Contingency Needed

In a competitive market, bridge loans allow buyers to make a non-contingent offer on a home, meaning they can close on a new house before their old house sells.

This increases their likelihood of securing a new home despite the funds being unavailable.

The Cons of Bridge Loans

As with all things, there are a few disadvantages to bridge loans.

Equity Requirements

To be eligible for a bridge loan, most lenders require the homeowner to have a minimum of 20% equity in their current home. In other words, loan applicants can borrow up to 80% of their loan-to-value ratio (LTV).

Financing Requirements

Most bridge loan lenders will only offer you a bridge loan if you agree to use the same lender for the mortgage on your new home.

Bridge loans also often have higher interest rates and APRs than traditional loans. Borrowers must also pay closing costs, an origination fee, legal fees, and administration fees.

Limited Borrower Protection

Bridge loan financing rarely has protections for the loan holder if the sale of the old home doesn’t go through. The loan provider could foreclose on the old property after the loan’s extensions expire or if the borrower cannot sell it.

Weighing the Pros and Cons of Bridge Loans

Understanding bridge loans allows you to weigh the pros and cons to see if this loan is right for you.

A bridge loan is an excellent option in the following situations:

  • It’s a seller’s market (where you need to act fast), and you’ve found a home you want to purchase.
  • The closing date for your current home is after the settlement for the new house, or you want to close on a new home before selling your current one.
  • You don’t have the funds for a down payment for a new property unless you sell your current home.
  • You found your new home, but the seller won’t accept a contingent offer (an offer contingent on the sale of the current property).
  • You need help temporarily paying for a second mortgage.

If a bridge loan doesn’t quite fit your needs, you can explore other loan options. Research different loan options, such as a bridge loan vs. a home equity loan vs. a home equity line of credit (HELOC).

Unlike bridge loans, home equity loans and HELOCs are long-term financing, also known as permanent financing. They both have longer terms and repayment periods, often between five and ten years.

Like bridge loans, home equity loans use the equity in your home as collateral. The loan is a one-time lump sum payment, making it ideal for major renovations. A HELOC, however, works like a credit card. You have a specific amount of money you can borrow and pay back as needed.

Apply for Your Loan Today

Now that you know more about the pros and cons of bridge loans, you can determine whether this loan is right for you.

If you need financial assistance during the home purchase process or want to refinance your current mortgage, come to The Associates Home Loan of Florida. We offer many types of loans, from bridge loans and HELOCs to traditional mortgages and more!

Apply now, and let us get you into the loan that best suits your financing needs.

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