Bridge loans are also referred to as bridge financing, interim financing, swing loans, or gap financing.
They’re a short-term financing tool that lets you borrow against your current asset. Homebuyers often take out a bridge loan against their current home to finance the down payment on their new home.
Bridge loans typically let you borrow money for up to a year. Interest rates on bridge loans typically fall between 8.5% and 10.5%, which means they’re more costly than traditional forms of long-term financing.
In this article, we’ll explain how bridge loans work, who offers them, the pros and cons, and whether they’re a good option for your financing needs.
Different Types of Bridge Loans
Bridge loans aren’t classified into specific categories. The differences between bridge loans often center around repayment method, loan term, and the interest rate.
For instance, there are different ways to repay the interest on your bridge loan.
Some lenders prefer lump-sum payments at the end of the loan term. Others prefer monthly payments.
Pros of Bridge Loans
Although they’re more expensive than other forms of long-term financing, bridge loans present multiple benefits.
Short time frame
Bridge loans are a strictly short-term financing option.
Unlike mortgages or college tuition loans, bridge loans require you to pay back your debt over a short amount of time.
During that shorter period of time, it’s less likely that you’ll suffer financial hardship that makes it impossible to repay your loan.
The application and underwriting process for bridge loans is generally faster than it is for traditional loans.
Additionally, it’s relatively easy to qualify for a bridge loan, assuming you qualify for a mortgage to purchase a new house.
Flexible repayment options
Bridge loans let you choose your repayment option. You can either repay your entire bridge loan before or after securing your permanent financing.
If you repay your bridge loan before securing your permanent financing, your payments will be structured in a way that lets you fully repay your loan over a certain time period.
Assuming you make your payments on time, your credit rating will improve, and you’ll qualify for long-term loans you’d otherwise be ineligible for.
If you repay your bridge loan after securing your permanent financing, then a portion of your long-term funding will go towards repaying your bridge loan.
Bridge loans are non-recourse loans, which means the lender can only seek repayment of the loan through the actual property.
As the borrower, you’re not personally liable for repaying the outstanding loan balance. If you can’t repay your loan, the lender will only be able to claim your property as collateral.
Cons of Bridge Loans
Despite their benefits, bridge loans present a few disadvantages.
Bridge loans require you to repay your loan over a shorter period of time than a mortgage or other long-term financing.
That means you’ll pay back your bridge loan over larger payment installments.
Bridge loans also tend to come with higher interest rates than long-term financing solutions.
Less flexibility from lenders
Because bridge loans are short-term loans, lenders are likely to be less flexible when it comes to payments. If you’re behind on your payments, be prepared for higher late fees and steeper penalties.
Relies on more permanent financing
Bridge loans rely on more permanent financing—they’re not a long-term financing solution.
However, long-term financing isn’t always available. For instance, if the housing market collapses, you’ll be left without funding, scrambling to repay your bridge loan.
Last but not least, bridge loans can be expensive.
In fact, bridge loans usually cost more than a traditional mortgage. Interest rates on bridge loans depend on i) your credit score and ii) the size of your loan.
Lenders typically approve bridge loans if you present both strong and stable finances. Oftentimes lenders require a minimum credit score (the exact number might vary) and a certain debt to income ratio. Overall, if your financial situation isn’t solid, you’ll struggle to qualify for any type of bridge loan.
Bridge Loans for Businesses
Bridge loans aren’t just for private homeowners.
Businesses can also use bridge loans to immediately purchase real estate or fund a short-term cost.
Just like regular bridge loans, business bridge loans typically come with higher interest rates, but they allow quick access to capital than traditional financing.
Some situations where your business might use a bridge loan include:
- To cover operating expenses while your business finalizes long-term financing.
- To obtain funds for an immediate real estate purchase.
- To capitalize on limited-time offers on business resources, inventory, etc.
Bridge Loans Lenders
You can obtain a bridge loan through a variety of different lends: banks, credit unions, and other financial institutions. That said, it’s most common to secure a bridge loan from your current mortgage provider.
If you’re interested in a bridge loan, make sure you call your lender first.
Additionally, while you search for a financial partner, avoid lenders who promise quick access to capital, lenders who charge high fees, or lenders who don’t have a quality track record.
Bridge Loan Costs
Bridge loans aren’t cheap.
Although they’re a great way to obtain temporary financing for your new property, remember that bridge loans usually cost more than a traditional mortgage.
Interest rates on bridge loans depend on i) your credit score and ii) the size of your loan.
Overall, interest rates on bridge loans range from the prime rate (3.25%) to 8.5% or even 10.5%.
Interest rates on business bridge loans range even higher, typically from 15% to 24%.
In addition to your interest rate, you’ll need to pay legal and administrative fees, along with closing costs.
Closing costs and fees for bridge loans hover around 1.5-3% of the total loan amount. These costs often include the following:
- Loan origination fee
- Appraisal fee
- Administration fee
- Escrow fee
- Title policy costs
- Notary fee
Before you commit to a bridge loan, remember to consider all the associated costs!
Bridge Loan Alternatives
If you can’t access long-term financing, bridge loans can be a great tool for obtaining funds.
However, they have their downsides, and they’re not the only tools out there.
Before you take out a bridge loan, consider other options including:
Home Equity Loan
A home equity loan lets you borrow against your home equity.
Compared to a HELOC (see below), a home equity loan is a lump-sum payment. Interest rates on home equity loans typically start around 2% above the prime rate.
If you’re a homeowner who knows exactly how much you need to cover the down payment on your new house, a home equity loan might be a great option!
Home Equity Line of Credit (HELOC)
A HELOC lets you take out a credit line against the equity in your current home.
Whereas home equity loans come in the form of a lump sum payment, a HELOC gives you access to credit on a revolving basis. These credit lines typically have a repayment period of up to 20 years.
20 years is a long time! That means you’ll have longer to repay your debt. Contrast that with the short repayment period offered by bridge loans.
Interest rates for a HELOC are generally the prime rate plus 2%.
Today, that would be around 5.5%. That’s way less than the 10.5% interest you might find yourself paying on a bridge loan.
All in all, a HELOC is a great alternative to a bridge loan.
You can draw on your line of credit as needed, you’ll enjoy a lower interest rate, and a longer repayment period.
Business Line of Credit
A business line of credit is a type of revolving loan that gives your business access to capital to cover short-term costs.
Business lines of credit aren’t issued in lump sums.
That means you’ll only pay interest on the money you draw against the line.
Bridge loans, on the other hand, are issued in lump sums—that means you’ll pay interest on the entire loan amount, even if you don’t use all of it.
Business lines of credit typically range from a few months to 10 years. Interest rates vary by lender, but many traditional banks offer business lines of credit with interest rates as low as 7%.
Business lines of credit can be a great alternative to bridge loans; however, it’s often hard to secure a business line of credit from a brick-and-mortar bank. Online banks offer business lines of credit, but they charge higher interest rates (5% to 99%).
With that in mind, only use business lines of credit to cover short-term or sudden, unanticipated expenses.
Also known as “piggyback loans,” an 80/10/10 lets you buy a home using two mortgages at once.
The first mortgage covers 80% of a home’s purchase price.
The second loan “piggybacks” on your first mortgage and covers another 10% of the purchase price.
The last 10% of the purchase price is your down payment.
Once your first home sells, you’ll use those proceeds to pay off your second mortgage.
Bridge Loans: A good option?
Short answer: it depends on your needs!
For the right homeowner, bridge loans can be a great idea. They offer a short repayment period, flexibility, speed, and are non-recourse loans. However, before committing to a bridge loan, it’s important to explore your options.
2-3 weeks, sometimes within 5 days. This is one of the major attractive features of bridge loans—their quick approval time. Contrast that with loans from a bank that take up to 30-45 days (or longer) for approval.
Not typically. Lenders tend to approve bridge loans only if the borrower can show strong and stable finances. Most lenders will set a minimum credit score and a certain debt to income ratio. If your financial situation isn’t ideal, or you’re stuck with a poor credit score, you likely won’t qualify for a bridge loan.