Bridge loans, also known as gap loans or swing loans, provide critical short-term financing to borrowers waiting on the sale of an asset or pending long-term financing. These loans allow borrowers to bridge the financial gap and cover expenses during transitional periods. In this comprehensive guide, we’ll explore bridge loans in detail – from what they are and how they work to who uses them and their advantages and disadvantages. We’ll also provide answers to frequently asked questions about these unique loans.
What Exactly Are Bridge Loans?
A bridge loan is a short-term loan secured by a borrower’s current asset, typically real estate. These asset-secured loans provide financing to qualified borrowers for a term between 3-12 months as they transition between financial events.
For example, a homeowner purchases a new home but has not yet sold their existing home. Not able to qualify for traditional financing with two mortgage payments, the borrower takes out a bridge loan using their unsold residence as collateral. This allows them to make the down payment on the new home as they simultaneously market the old home for sale.
Bridge loans help borrowers bridge an economic gap, avoid missed opportunities, and cover carrying costs during the transition from one asset to another.
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Common Types of Bridge Loans
The most common types of bridge loans include:
Real Estate Bridge Loans: Allow home sellers to purchase a replacement home before listing their existing property. Borrowers can tap their home equity for down payments, closing costs, renovations and carrying two mortgage payments.
Business Bridge Loans: Provide operating capital to entrepreneurs and small business owners awaiting slower, long-term financing such as SBA loans, merchant cash advances or equity investments. These loans allow daily business operations to continue uninterrupted.
Commercial Bridge Loans: Help investors and developers with down payments, deposits, renovations and other costs associated with acquiring commercial real estate before finalizing permanent financing. Payoffs often come from the sale of another property or approval of a longer-term commercial real estate loan.
How Do Bridge Loans Work?
Bridge loans provide financing using the borrower’s current assets or properties as collateral. Although requirements vary between lenders, here is how they generally work:
Loan Amounts: Lenders may finance up to 80-90% of the value of the collateral asset, often determined by an appraisal. Approved loan amounts typically range from $100k-$10M+
Interest Rates & Fees: Due to their short terms and relative risk, bridge loans carry higher interest rates than standard mortgages, often 2-4 percentage points above the Prime Rate. Large origination fees between 2-5 points are also common.
Collateral: The bridge loan is secured using collateral the borrower already owns. This is often the property they intend to sell. Additional assets may also be used.
Payments: Some bridge loans feature interest-only payments until maturity. Others require no payments until the end, when all interest + principal is due as a balloon payment.
Term Lengths: Most bridge loans feature short 3, 6 or 12 month terms where the borrower is expected to refinance or sell their collateral asset and repay the bridge loan.
End of Term: At maturity, the bridge loan must be paid back or refinanced into permanent financing. If the borrower hasn’t sold their property or qualified for refinancing, lenders may extend the bridge loan if additional fees are paid.
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When Are Bridge Loans Used?
Bridge loans help borrowers safely navigate the gray areas between financial events. Common examples include:
Purchasing New Home Before Selling Old One: Home sellers often prefer bridge loans because they allow offers on replacement homes without difficult, often unrealistic, contingencies that require selling an existing property first.
Cash Flow for Small Businesses: Fledgling operations rely on bridge loans while awaiting slower funding like SBA 7(a) loans, equipment leases, or merchant cash advances. These loans allow owners to bridge gaps in cash flow and protect their business credit scores.
Commercial Real Estate Transactions: Investors use bridge loans to place competitive cash offers, fund deposits, start renovations or avoid missing unique opportunities while arranging long-term financing.
Who Uses Bridge Loans?
Bridge loans serve almost anyone facing a large purchase combined with the impending sale of a valuable asset. Typical users include:
Home Sellers & Home Buyers: Those moving residences, particularly to new geographic areas. Bridge loans allow homeowners to purchase before listing their existing property.
Landlords & Real Estate Investors: Investors rely on bridge loans to fund deposits, renovations and purchases as they continuously buy, update, and sell rental properties for profit. These loans allow more deals per year.
Builders & Developers: Construction loans don’t fund land acquisition. Developers use bridge financing to secure property and take advantage of opportunities before lining up construction loans, government funding, or presales.
Business Owners: Startups & small business owners use these loans to cover inventory, payroll, marketing and operational expenses while awaiting slower funding like SBA loans.
Bridge Loan Requirements
While bridge loans are easier to qualify for than standard mortgages, approval is largely based on:
20-30% Equity in Collateral: Bridge loans usually cap out at 70-80% loan-to-value ratios. Enough equity must support the loan amount.
650+ Credit Score: Most programs require credit scores of 650+, although some programs exist for borrowers with scores around 600.
Clean Payment History: On-time mortgage, auto, credit card and installment loan payments help qualify. Collections, defaults and bankruptcies challenge applications.
Low DTI Ratio: Debt-to-income below 50% improves probability for approval. Total monthly debt obligations, including the bridge loan payment, are considered against monthly income.
Sufficient Collateral Value: The market value of the bridge loan’s collateral asset must sufficiently secure the proposed loan amount. Favorable appraisals support better leverage and improve loan eligibility.
Bridge Loan Pros & Cons
Bridge loans provide ingenious solutions but, like any financing, feature notable pros and cons:
Pros
- Quick financing for competitive opportunities
- Avoid stalled home sales lined with multiple contingencies
- Cover business expenses through revenue slowdowns
- Immediate access to large capital
Cons
- Short repayment timelines
- Higher interest rates than traditional loans
- Large origination & processing fees
- Risk of foreclosure if not repaid promptly
How Much Does a Bridge Loan Cost?
Bridge loans provide rapid access to tens or hundreds of thousands in capital, but often with higher costs than longer-term mortgages or business loans. Typical costs include:
Interest Rates: Usually Prime + 2-4%, currently 11-13% APR
Origination Fees: Up to 2-5% of the loan amount
Processing Fees: Around $2,500 on average
Third Party Fees: For appraisals, credit checks, flood certifications, etc.
Prepayment Penalties: Some lenders charge fees if bridge loans are repaid early
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How Long Do You Have to Pay Back a Bridge Loan?
Most bridge loans feature relatively short 3, 6 or 12 month repayment terms. At maturity, the bridge loan must be repaid in full or refinanced into an eligible permanent financing option. Some programs do allow interest-only payments over 12 or 24 months before a large final balloon payment.
While designed to be short-term, some lenders may allow 1-3 month extensions on bridge loans after reapplying and paying extension fees. However, extensions are not guaranteed if the borrower has been unable to sell their original property or finalize long-term financing.
Where Can I Get a Bridge Loan?
Many banks, credit unions, mortgage lenders and alternative lending companies offer bridge loan programs. Due to their expertise with short-term real estate lending, private money lenders and hard money lenders represent some of the most active sources.
Online lenders also represent an excellent option as they leverage predictive technology, digital underwriting, and investor money to quicken processes while offering competitive rates and flexible qualifying standards.
What Are Some Bridge Loan Alternatives?
Other mid-term financing options similar bridge loans include:
Home Equity Loans & HELOCs: These loans provide larger sums of money, also backed by residential real estate collateral. However, lending limits based on available equity could constrain funding compared to bridge loans.
401k & IRA Loans: Individual retirement account holders can sometimes borrow against their own savings. However, 401k loans require employment and IRAs limit financing to either $50k or 50% of the account balance, whichever is less. Plus, retirement savings suffer lost market gains while funds are borrowed.
Hard Money Loans: Like bridge loans, hard money loans use real estate as collateral and carry higher rates & fees. But hard money imposes stricter lending limits at lower LTVs. Their terms may better suit those with lower credit scores or who need funds faster.
Business Lines of Credit: Also expensive, lines of credit provide registered businesses with reusable pools of fast capital. But amounts depend on business revenues and approval is generally capped below $500k – much lower than many bridge loan borrowers require.
When deciding between bridge loans and alternatives, short-term capital needs, collateral values, equity positions in existing assets, credit scores, business structures, and repayment timelines all play determinative roles.
Conclusion
In summary, bridge loans provide short-term financing to qualified borrowers who need urgent capital during transitional property sale periods or while they await approval for longer-term funding options. By using an existing property as collateral, bridge loans allow borrowers to cover purchase deposits, renovations, carrying costs, inventory, payroll, and more while they navigate between financial events.
But these uniquely structured loans also carry downsides like large origination fees, higher interest rates, and relatively short repayment timelines. Default risks also challenge borrowers if they fail to refinance or sell their original collateral properties in time.
Overall, bridge loans deliver useful solutions when traditional financing creates gaps between financial opportunities and obligations. Just be sure to have reliable exit strategies and enough equity cushion to guarantee the bridge can feasibly be repaid or refinanced within the loan’s term.
Frequently Asked Questions
Still have questions about bridge loans and how they work? Check out answers to the most commonly asked questions below:
How quickly can I get a bridge loan?
Approvals often come in 1-5 days, with funding in 5-10 days. Very fast programs fund loans in around 2-3 business days from completed applications.
What credit score is needed for bridge loan approval?
Minimum scores range 550-650 across programs, but superior pricing and terms go to those with scores above 700. Mismanaged credit histories face higher rates and fees, or denials.
Can I get a bridge loan to buy land?
Yes – raw land, improved land and commercial/residential lots all qualify as eligible collateral at some bridge loan lenders. More equity is often needed, so maximum leverage ratios usually top out at 50%.
What if I can’t sell the house/property securing my bridge loan?
Before your bridge loan matures, contact your lender to discuss options like refinancing with a longer-term product or extending the bridge for additional fees. If you still cannot sell or refinance the property in time, the lender can foreclose to recoup their capital.
Do I need to make monthly payments on a bridge loan?
Most lenders offer interest-only bridge loans, where monthly payments cover some or all accruing interest charges. Others feature larger balloon payments with no monthly payments due during the actual loan term.
Can I get a bridge loan for an investment property?
Many bridge loan lenders finance non-owner-occupied residential and commercial properties. More equity is often required compared to primary residence lending limits. Expect maximum LTVs around 70% for investment real estate bridge loans.
