What Is a Bridge Loan?

What Is a Bridge Loan?

Bridge loans are short-term financing options used in real estate transactions to provide cash flow during a transitional period, such as moving from one home to another. They can be used to finance a new home or pay off existing debt. 

However, it’s important to note that, like any form of financing, bridge loans have their own set of benefits and drawbacks. The team at King James Lending is here to help you understand your options so that you can invest wisely. 

How Does a Bridge Loan Work?

Bridge loans are a tool often used by sellers in difficult situations. They can vary in terms, costs, and conditions. Some bridge loans pay off the old home’s mortgage at the time of closing, while others add new debt on top of the old. 

Some have monthly payments, while others require lump-sum interest payments. However, most bridge loans share some general characteristics, such as;

  • They usually have a 6-month or 12-month term and are secured by the borrower’s old home.
  • Lenders usually require the borrower to finance the new home’s mortgage with the same institution.
  • Interest rates can range anywhere from the prime rate to the prime rate plus two percentage points.
  • Applying for a bridge loan is similar to applying for a conventional mortgage. The lender will evaluate creditworthiness based on factors such as credit score and debt-to-income ratio.
  • Most lenders only allow borrowers to borrow up to 80% of the current home’s equity.
  • Bridge loans can be costly, with closing costs of a few thousand dollars and an origination fee of up to 2% of the loan’s original value.

However, bridge loans do not offer protections for the loan holder if the sale of the old home falls through, and the lender could foreclose on the old property in such cases. Given these risks, it is vital to consider a bridge loan carefully based on what you can afford and how quickly homes are selling in your market.

Who Uses This Type of Loan?

Bridge loans are typically used by homeowners looking to buy a new home before selling their current home. This allows them to move into their new home without having to wait for the sale of their current home to close. It also allows them to avoid the hassle and expense of moving twice.

Investors and developers also use bridge loans to finance the construction or rehabilitation of a property. These loans are typically used to bridge the gap between the completion of the project and the permanent financing that will be used to pay off the loan.

Bridge loans are typically secured by the existing property that is being sold, and they usually require a down payment of at least 20%. The interest rate on a bridge loan is usually higher than the interest rate on a traditional mortgage, and the loan term is usually shorter, typically one year or less.

It’s important to note that bridge loans can be a good option for those who are looking for a short-term solution, but they can also be risky. Since the existing property secures the loan, if the sale of the property does not close, the borrower may be forced to default on the loan and risk losing their property. Additionally, the high-interest rates and short loan terms can make it difficult for some borrowers to repay the loan.

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In summary, a bridge loan is a short-term loan that is used to finance the purchase of a new property before the sale of an existing property is complete. It can also be used to finance the construction or rehabilitation of a property. 

If you’re ready to build your investment portfolio, a bridge loan may be the way to fund your next project. Contact our team to learn more about your options and see how we can become valuable partners in your investment career.