Also known as a swing loan, or interim financing, a bridge loan is a type of very short-term loan that is normally given out to an individual or a business until they can secure permanent financing. Bridge loans are commonly used in the housing market, and are generally used by home buyers who are buying a new home when their old home is still for sale. Bridge loans feature fairly high interest rates and must be backed by collateral, such as your home.
When you use a bridge loan to purchase a new home, but your old home is still on the market, the current home is used as collateral, and the funds from the bridge loan are generally used as a down payment towards your new home. In this case, the bridge loan will be repaid when the old home is sold.
Advantages and Disadvantages of a Bridge Loan
When looking for a new home either to live in, or just for a short-term investment, you will most likely need a loan. Unfortunately, securing a conventional loan will take you a lot of time and will require you to respect some strict mortgage loan qualification requirements. Another problem you might face is that, if you plan on buying a new house while your current house hasn’t sold yet, you will most likely be denied a conventional loan, because you will be considered a higher risk for default. Your best choice in this situation is to take out a bridge loan, which features a few distinct advantages over conventional loans. Here are the most important ones:
- Bridge loans are short-term loans. Most conventional loans are designed for people who want to pay for a mortgage or college tuition, and require you to pay the loan off over a long period of time. A long-term loan will increase your risk of suffering some kind of financial issue. Bridge loans, on the other hand, are designed to be paid off in full before you receive the long-term loan for your new home.
- The option to choose when to repay the bridge loan. Bridge loans can be repaid before you receive the long-term mortgage loan needed to buy a new home, or after receiving this loan. If you repay the bridge loan in full and on time before you receive the new loan, you will significantly increase your credit score, allowing you to qualify for more mortgage loan options.
- No set qualification guidelines. Bridge loans don’t come with any set limits or qualification guidelines, like a conventional loan would have. Bridge loans can also be turned into regular mortgages by the lender.
Of course, like any loan, bridge loans come with advantages and disadvantages. Here is what you should keep in mind before applying for a bridge loan:
- Larger payments and penalties. Being short-term is an advantage that bridge loans have, but this may also be regarded as a disadvantage. Repaying the loan in a short period of time means that the monthly payments will be larger than with a conventional loan. Lenders are also stricter when it comes to late or missed monthly payments on a bridge loan. The fees and penalties are larger for a missed payment on a bridge loan than for missed payments on a conventional loan.
- Dependent on more permanent financing. You may rely on the mortgage loan that you are applying for in the near future to repay the bridge loan, but there are no guarantees that you will receive that loan. In case not everything goes as planned, you will have to repay the bridge loan from your own pocket. Another choice would be to take out a new loan in order to pay the bridge loan, but that could lower your credit score, create new debt for you, and ultimately make it harder for you to receive financing for a new home.
Before deciding on a bridge loan, make sure that you understand what your rights and responsibilities are, and carefully weigh in on both the advantages and the disadvantages of this type of loan. Your financial situation is the most important factor to be taken into consideration before deciding which path to take.