How Does a Bridge Loan Work?

It becomes tough to buy a new home before selling the current one if you do not have cash in hand. Homeowners who plan to buy a new house rely on the money they will get by selling the current home. You are lucky if the closing date of both houses aligns but it rarely happens. If you have decided on a new house to buy, you cannot wait to sell the current one because in the meantime another buyer may come and snatches it up. A Bridge loan can help at the moment you are stuck in this precarious financial situation. This loan can ‘bridge’ the financial gap between buying a new home and selling the current one. The application process for this kind of short term loan can be relatively faster than another kind of loan but it can be expensive and risky too.

Let’s have a look at how Bridge loans work and what the structure of their repayment is.

What is a Bridge loan?

A Bridge loan is a short term financing solution that is typically used in real estate transactions. When a homeowner wants to purchase a new home but selling the current one is taking time, a Bridge loan can help in bridging the time gap between the two. The maximum amount a Bridge loan can fund you is usually 80% of the combined value of the current Home and the home you want to buy. Though each lender has different standards and policies.

A buyer typically goes for a Bridge loan when they want to purchase a new home before selling their existing residence, to raise the cash for a down payment.

How does the Bridge loan work?

 A bridge loan, also known as interim financing, gap financing or swing loans help in filling the gap during times when financing is needed but not yet available. Lenders can customize bridge loans as per the situation.

Bridge loans help homeowners to purchase a new home while waiting for the existing home to sell. This keeps homeowners some peace of mind as they purchase that dream home that might be snatched up by another buyer if a bridge loan could not help. The borrower has to pay a premium interest on this type of loan. 

To get a Bridge loan, you have to contact a bridge lender. Not all lenders set preconditions or guidelines for Bridge loans. You can get a Bridge loan either backed by your existing property or secured by the property being purchased.

Some common reasons that people seek out a Bridge loan include:

  • Inability to raise money for down payments for a new home that they want to purchase
  • A quick need to secure a new home
  • The closing date of your new purchase is scheduled before the closing date for the sale of your existing home
  • A preference to secure a new home before listing your current residence for selling

Generally, hard money lenders offer a Bridge loan in two different ways:

  • Either the secure Bridge loan on the existing residence of the borrower
  • Or they secure a Bridge loan on the property being purchased

Similarly, Bridge loans tend to:

  • Have to be repaid in less than 1 year
  • Have higher interest rate as compared to traditional loan
  • Be riskier
  • Secured by the borrower’s property as a form of collateral
  • Be issued by the lender with whom you agree to finance your current mortgage

How do you repay the Bridge loan? 

Typically the repayment schedule of a Bridge loan is 12 months or less. Most borrowers pay off their Bridge loan with the money they get by selling the existing house but there are other options available too. The repayment schedule of Bridge loans can be structured in different ways but commonly, they have a balloon payment at the end.

The payment structure of a Bridge loan may vary from lender to lender. Some may require you to make a monthly payment while others require a mix of upfront and/or end-term or lump sum payment charges.

Note that applying for a Bridge loan works similar to the traditional loan. Your loan officer will analyse your documents and other information to check if you are qualified for the loan or not. The majority of Bridge loan lenders allow applications to borrow a maximum of up to 80% of their loan-to-value ratio (LTV).