What is a Bridge Loan: How it Works

Definition of Bridge Loan?

As expected, the term “bridge loan” is used for a Loan that gets approved for covering financial gaps for corporations and individuals for both professional and personal purposes. The other terms used for the loan are “gap financing” or “swing loans”.

There are some markets, where these loans are more popular than the others, for instance, the real estate market. If you are a potential home buyer, who already owns a home, then this loan type might turn out to be absolutely invaluable for you. It will serve as a perfect temporary solution, if you are looking to cover the financial gap between selling your present home and purchasing the new one.

On the other hand, if you are a business owner, a bridge loan would provide you with some short-term cash flow as your business would near long-term financing. Read on to know more about this short-term loan

At what rates bridge loans are available?

Like most other loan types, the rates of bridge loans also vary depending on a series of factors including the existing prime rates and your creditworthiness. However, typically you can expect to get this loan for a rate, which is nearly 2% more than the average for the standard fixed-rate loans.

At times, these loans come with massive closing costs, which assist in offsetting the high level of risk lenders have. Risks associated with a bridge loan may include securing the loan using a property which requires rehabilitation for meeting the lending standards, providing the loan amount to people who don’t meet the criterion required to be fulfilled for conventional financing, lending money under special circumstances (situations in which the majority of the traditional lending organizations/lenders don’t approve loan applications), and so on.

As a bridge loan needs to fight with so many risk factors, as a lender you should expect bigger up-front expenses and higher rates. If you are not sure, whether this loan type would work for you or not, it would be wise for you to speak to a qualified and experience advisor.

Example of a Bridge Loan

Alex, a resident of Austin, Texas has purchased a new home, but is yet to sell off his current home. To deal with the situation, he has taken a bridge loan; the loan amount would allow him to keep making the mortgage payments timely. Let us assume that in Texas, bridge loans are offered at an interest rate of 8.5%. According to the loan terms, there will be no payment for a period of 4 months and the amount of interest would be accumulating all through the loan term. The total amount of interest would be due once Alex’s old house gets sold. The pointers below elaborate the usual bridge loan fees that Alex will have to pay.

Loan origination fee- at least 1% of the amount borrowed

- Wiring fees $75

- Notary fees $40

- Title at least $450

- Escrow fee $450

- Appraisal fee $475

- Administration fee $850

The above numbers show that although the bridge loan helped Alex to manage the situation by offering additional funding, it became quite a costly affair for him.

How Bridge Loan works

It’s true that there are a few lenders who would need you to have a reasonably impressive credit score or might require your debt to income ratio to be low, but most lenders offering bridge loans wouldn’t require you to meet any strict criteria. That’s probably because this loan type is often dependant on long-term loans borrowers are looking to procure.

Let’s explain using Alex’s example. As Alex got the mortgage for his new house from a regular lending organization/lender for a standard interest rate, the lender offering him the bridge loan was not bothered by factors like high debt to income ratio. Things would have changed significantly if Alex required a large amount as bridge loan for the new mortgage. In that case, the lender offering the loan wouldn’t have approved Alex’s loan application if his debt to income ratio was higher than 50%.

A bridge loan, as its name suggests, is meant for bridging the financial gap for people and organizations for both personal and professional purposes.

The loan would serve you well if you are waiting for a long term financing, but need some instant cash flow.

As a result of having several risk factors associated with it, bridge loans often have high interest rates and hefty initial expenses.