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Home » The Pros and Cons of Bridge Loans

The Pros and Cons of Bridge Loans

Milena PetrovskaKyle DrummondbyMilena PetrovskaandKyle Drummond
24.08.2020
Reading Time: 7min read
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how does bridge loan works

Shuttershock / DenisMArt

Perhaps you’re moving out of state soon to start a new job, and maybe your new house isn’t livable yet; perhaps you’ve settled on a downgrade that will make you breathe a whole lot easier. Whichever is the case, there’s no help of man that can turn a move into anything other than the most stressful thing short of an alien invasion.

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The chasm of time in between truly leaving your old home behind and settling into your new one is always nerve-racking, including financially. This is why everyone should know about the pros and cons of bridge loans.

What Is a Bridge Loan and How Does It Work?

bridge loans
Shuttershock / By Jaruwan Jaiyangyuen

Like everyone right now, I work from home (thanks, corona!). When my internet went out and the landlord couldn’t (or wouldn’t) get it fixed for several weeks, I had no choice but to rent a second apartment as an office. I was also planning to move anyway and happened to stumble on a good deal, so at present, I’m paying for no fewer than three properties even though I only use one.

Assuming you have some savings, this is okay for a month or two, but it’s not exactly a long-term plan. Nor may it even be possible if you’re already carrying a mortgage. A good rule of thumb is to spend no more than 25% of your income on mortgage payments, yet the majority of Americans are already exceeding this. Even if you’re approved, increasing your debt burden – even if it’s only until you sell your current home – will negatively affect the interest rates you’re offered.

This is where bridge loans come in. Ideally, you don’t want to sell your old home before checking out the real estate market: buying under pressure is never a good idea, and the price of living in a hotel while your stuff is in storage can easily exceed your closing costs (typically 2% to 5% of the purchase price). It’s definitely easier to move out or at least sign on your new home while your house is still on the market, rather than being pushed out by the new occupants.

To do so (and avoid a lot of pressure), you’ll probably need a loan bridge – a bridge in loan form that gives you ready cash for things like moving expenses, lawyer fees, and especially, a down payment on your new home. To get specific:

  • Bridge loans are short term (usually a couple of months), while mortgages are long term.
  • A bridging loan typically carries higher interest than a mortgage, but less than a personal loan.
  • Bridge loans are secured by the equity you have in your current home.

How Much can You Borrow on a Bridge Loan?

In general, you can borrow up to 80% of the value of the part of the home you own. If the property can be sold for $100,000 and the balance on your mortgage is $50,000, you can borrow $40,000. Some lenders actually allow you to ask for as much as 90% of your equity, and many of them are flexible about lending to individuals with relatively low credit scores. Then again, if paying both a mortgage and a bridge loan will strain your debt-to-income ratio, you may only be able to borrow 50%.

However, as all mothers like to say: “just because you can doesn’t mean you should”. Home buying is already a financial juggling act, and adding bridge financing into the mix just complicates things further. With bridge loans as with all credit, the best advice for borrowers is to lend as little as your situation allows.

Hustling Like a Real Estate Mogul: The Pros, and the Cons, of Bridge Loans

The most important thing to understand about bridge loans is that their terms are typically not extended: if you’re unable to settle up when the loan is due, you’re in trouble. Should your current home not sell, you may have to look at another type of short term loan, perhaps using your new home as collateral. If you don’t plan conservatively, this may mean having to accept high-interest monthly payments.

The Pros of Taking out a Bridge Loan

Some things that can induce you to look at this kind of loan are:

  • You may have a lot of money tied up in your home, but it’s not available until that home sells. A bridge loan lets you use your equity as cash.
  • If you already have a mortgage, bridge loans are typically easier to get than other types of loans, as well as faster.
  • Bridge loan interest rates are lower than those of many alternative loans.
  • Time is money. A bridge loan gives you time to seek out good options on the real estate market. You also don’t have to restrict your search to properties whose sellers will accept “contingent on sale” offers.
  • The convenience factor: you can be in your new home while agents and buyers traipse around in the old one, and you have more freedom in choosing closing dates for both.
  • Part of a bridge loan can be used as you please: to cover closing costs, perform renovations on the new home or pay for assessor fees.

The Cons of Taking out a Bridge Loan

Given all the above, a bridge loan may seem like an elegant solution for any homeowner who wants to sell their existing home without immediately taking on a new mortgage. There are some serious caveats, though, and we’d be failing in our duty if we didn’t warn you about them:

  • There’s no such thing as free money. In addition to the high interest, you may need to pay origination fees, an appraisal or both.
  • While the basic idea behind all bridge loans is the same, picking one can still be a complex decision due to the many different options. Some don’t require you to make payments for the first several months but hit you with a large interest payment at the end of the loan period. Some use part of the money you borrow to pay off your old mortgage, others not.
  • You will probably be carrying both a mortgage and a bridge loan for a short period.
  • Like with all secured loans, you run the risk of losing your collateral. If you can’t repay the debt on time, the bank may even foreclose on your old house.

Is a Bridge Loan Worth It?

The logic behind a bridge loan kind of breaks down in a buyer’s market: one where there are many properties for sale and little demand. If you’re not sure that your house will sell within a reasonable period of time, you should really think twice about getting a bridge loan. Though nobody really knows, it is possible that you may end up stuck with a bridge loan, a new mortgage plus your existing one while your old house sits languishing in a depressed housing market.

On the other hand, when used strategically, a bridge loan can work entirely to your benefit. If you have the opportunity to snatch up a new property at a good price, even a business or buy-to-let premises, bridge loans can help you get the cash you need until you can negotiate a more permanent mortgage. In some cases, this kind of financing may save your bacon: if you suddenly have to move across the country to accept a job, a bridge loan plus your savings may enable you to buy a new property immediately. If the closing date on your new house happens to be earlier than that of your old house, a very short-term bridge loan offers a simple solution.

Bridge Loans Pro Tips

In case you’ve already made up your mind that a bridge loan is for you, we’d like to share the following tips:

  • Shop around! Your existing mortgage provider may already have approached you about bridge loans, but perhaps other lenders offer better interest rates and other terms.
  • Home equity loans or lines of credit may work out much cheaper, so look into these in addition to bridge loans.
  • Remember that an occupancy date and closing date are different things. If you find a buyer who’s flexible about when they can move in, you may not need a bridge loan at all.
  • Bridge loans are often provided by the same institution that issues the new mortgage; in fact, this is often a requirement. You’ll need to carefully evaluate both packages.
  • The fees attached to a bridge loan often outweigh the interest you’ll pay – study the contract carefully.
  • If time is running out and your old property is still unsold, take action ahead of time: a new loan like a HELOC may take a month or longer to be approved.

Hopefully, after reading through the above, you’ll have a firm grasp on the pros and cons of this kind of equity-backed credit. We hope some of this information helped you; that’s what we’re here for. We’re also eager to learn more about your experiences with bridge financing, so why not share your story in the comments?

Milena Petrovska

Milena Petrovska

Content Manager
Milena holds a MA in Economic Sciences and has always been passionate about writing for the finance niche. She loves discovering new ways of improving personal wealth as much as she loves to share them with her readers. In her free time, Milena enjoys playing board games and going on road trips.

Kyle Drummond

Kyle Drummond

Financial Expert & Personal Advisor
I work with high net worth individuals and families, helping them achieve their financial goals. My approach begins with a conversation, evolves into a detailed, holistic financial plan and continues with the implementation of financial solutions. I focus on individual, customized investment strategies, risk management, and asset transfer strategies.

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