What Is a Bridge Loan?

Acquiring a loan is a complicated process. Typically, you don’t want to have more than a single loan at a time, as it becomes increasingly difficult to pay off multiple interest rates.

Furthermore, lenders are less likely to give you an additional loan in the first place if you have existing debt.

Even if a lender is willing to give you a new loan, he or she is in a much stronger position when negotiating with you due to your outstanding payments. So essentially, a bridge loan acts as a temporary real estate loan to bridge the gap between one property loan and another.

As you can expect, there are advantages and disadvantages to getting a bridge loan, but only your own financial situation can determine whether a bridge loan is suitable for you or not.

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Generally, bridge loans are better for companies to use, but sometimes bridge loans can be a great way for homebuyers to coordinate the selling of their current property and the buying of a new one. The following information explains exactly what bridge loans are and what the advantages and disadvantages are for both companies and real estate buyers.

What are bridge loans?

Simply put, bridge loans allow people or companies to have an immediate cash flow, which is used to either secure permanent financing or to remove an obligation on an existing loan. The name of the loan references how the loan bridges the gap when financing is not yet available but is actually needed to complete your purchase. These loans are short-term, typically lasting up to one year. Though useful, these loans do come at a cost. Bridge loans come with high interest rates and are often backed with collateral, such as inventory or real estate.

What are bridge loans used for?

Companies use bridge loans when the company needs to cover shortfalls. If the company needs to repay one loan before acquiring a new long-term loan, they may use a bridge loan. For example, if a company has a round of equity financing that it expects to close in six months’ time, it may obtain a bridge loan to use as working capital in order to cover things like rent, utilities, payroll and inventory costs.

Companies also commonly use bridge loans for mortgages on business properties. For example, if the mortgage loan on the company office is due before the company can get a suitable replacement mortgage loan, the company can use a bridge loan to pay off its current mortgage. Once a new long-term loan has been secured, the company can then pay off the short-term bridge loan.

On the other hand, real estate buyers make use of bridge loans in order to buy a property before they have actually sold their existing residence. So, effectively, real estate buyers can borrow a down payment for their new property. Generally, real estate bridge loans are only offered by lenders to borrowers who have low debt and an excellent credit rating.

What are the pros and cons of bridge loans for real estate buyers?

If you want to buy a new home before you have sold your current one, navigating the finances of how you do this can often be difficult. By obtaining a bridge loan, you can basically:

  1. Pay the down payment on the residence you wish to buy.
  2. Move quickly to complete the purchase.
  3. Enter your current home into the competitive real estate market.

Bridge loans can be an important resource to homebuyers for a number of other benefits as well. For instance, a bridge loan removes the need for contingent offers. If not, it can add a contingency to a new property’s contract, stating that you don’t have to buy the new home until your present residence has sold. This means sellers are more likely to accept your offer.

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It also means prospective purchasers of your current home have more time to finalize their deal. Another great advantage is that bridge loan payments are not usually due until several months after you close the loan.

When it comes to cons, unfortunately, not only are there disadvantages attached to bridge loans, they can actually carry serious risks. The cons are numerous and include the following:

  • The biggest risk of all is foreclosure. The security on your bridge loan is your old residence. If you default on your loan, the lender could foreclose on the property. This means you end up with more debt than you had prior to taking out the bridge loan, and you could be left without a home.
  • Another disadvantage of bridge loans is how costly it can be to obtain funds. The costs and fees associated with bridge loans can completely overturn the benefits of taking out the loan in the first place. The lender of your bridge loan may stipulate you are required to obtain a new mortgage from them in exchange for the loan. This means you limit your ability to compare mortgage rates. As a result, you are unlikely to get a good deal.
  • An additional disadvantage is that bridge loans can sometimes be difficult to obtain for real estate buyers. The lender must qualify you to own two homes. And, in most situations, the lender does not rule in your favor. Making two mortgage payments at the same time as accruing interest on your bridge loan can cause a huge amount of financial stress as well.

What are the pros and cons of bridge loans for companies?

The main advantage of bridge loans for companies is that companies typically qualify for a bridge loan more easily than a long-term loan. Because bridge loans are quick-fix solutions and do not provide long-term answers, companies are willing to pay the high interest rates and higher loan origination fees associated with a bridge loan. Another advantage of a bridge loan is that companies can typically pay off the loan at any time and not have to pay prepayment penalties. Bridge loans solve here-and-now financial problems and are easy and quick to obtain.

The biggest disadvantage of bridge loans for companies is the expensive price. The quicker and easier it is to obtain a loan, the higher the financing costs are. The costs accrued from taking out a short-term bridge loan are much higher than those of conventional long-term loans.

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