What Is a Bridge Loan and How Can It Be Used?

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Imagine finding a great investment opportunity. Maybe you’ve found a rundown apartment building that wouldn’t take much to renovate. The only problem? You can’t secure traditional financing through a bank. What are your options? Getting a bridge loan may be the best solution.

If you’re considering this financing option, it’s essential to understand the bridge loan meaning, how it works and where to get one.

What is a Bridge Loan?

Bridge loans are short-term loans designed to give borrowers fast access to capital. Homeowners, for example, may use a bridge loan to meet financial obligations in between the sale of their current home and the purchase of their new home. In addition, a bridge loan can be used to take advantage of an investment opportunity like the one mentioned above in the commercial sector.

The loan provides the funds needed to cover the purchase of the property. This allows you to acquire the property without having to wait for loan approvals.

Typically, bridge loans have a term of six months to three years (12 months is the average), and they come with a higher-than-average interest rate. These loans are backed by collateral, too.

Bridge loans can be used in the residential and commercial sectors.

How Does a Bridge Loan Work?

A real estate bridge loan allows borrowers to quickly close on a deal before securing a mortgage or another long-term loan. The bridge loan can pay off the mortgage on the old property and fund the new home purchase.

Each lender will have its own terms, rates and structures. It’s common for lenders to require a balloon payment at the end of the term.

Generally, bridge loans are only available to people with excellent credit and who have quite a bit of equity in their property. Rarely do these loans allow you to borrow more than 80% of the value of the combined properties.

Qualifying for a Bridge Loan

To qualify for a bridge loan, companies must meet several requirements. Prospective agents will consider:

  •         DTI (debt-to-income) ratio: In most cases, the DTI requirement is the same as a regular mortgage. Total monthly payments on the loan will be divided by your monthly income.
  •         Equity in the property: Generally, lenders will only offer a maximum bridge loan of 80% LTV (loan-to-value). You will need at least 20% equity in a property to acquire a bridge loan.
  •         LTV ratio: The LTV represents the loan’s value relative to the property’s value. Therefore, a lower LTV equates to a lower risk.

Of course, lenders may also have other requirements that you will need to meet.

The Benefits of a Bridge Loan

There are several benefits to taking out a bridge loan, such as:

  •         Having quick access to cash. In addition, the funding and application process is typically much quicker compared to a traditional loan.
  •         Having the ability to seize investment opportunities. Bridge loans give you financial flexibility so that you can move forward with your plans.
  •         Having the ability to remove contingencies. The fewer obstacles in the way of the sale, the greater the chance of success.

The Drawbacks of a Bridge Loan

While there are several benefits of bridge loans, there are drawbacks that also need to be considered.

  •         Bridge loans usually have higher interest rates than traditional loans. The higher interest rate is reflective of the higher risk the lender is taking by extending the loan.
  •         There are restrictions with taking out a bridge loan. As mentioned previously, you can typically only borrow up to 80% of the combined values of the properties.
  •         You must have ample equity in your property to qualify for a bridge loan.
  •         Bridge loans are backed by collateral.

In many cases, the advantages of a bridge loan outweigh the drawbacks because they allow you to take advantage of a property purchase without having to wait for your current property to sell.

Where to Get a Bridge Loan?

Bridge loans can be obtained through credit unions, banks or with the help of a real estate financing firm. Terms, conditions and rates will vary from lender to lender. When you work with a real estate financing firm, financial advisors can help you find loans that meet your needs and offer favorable terms.

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