A bridge loan is a short-term loan that is used to cover a temporary shortfall of funds. A bridge loan has a short repayment span, usually six months to one year in duration. Bridge loans can be secured by both homeowners and business owners for various purposes when they expect a lump sum payment soon. Expected funds could be from a home sale, in the case of a homeowner, or the expectation of funding, in the case of a business owner.
Bridge loans usually carry higher interest rates because they are short-term loans, so borrowers must know when a bridge loan is necessary instead of longer-term loans with lower interest rates.
Interest rates for bridge loans depend on the borrower’s credit score, the loan’s duration, and the loan’s collateral. Just like with most loans, a better credit score will get a borrower lower interest rates. However, if a borrower’s credit score is low, getting approved for a bridge loan will come with a much higher interest rate.
When to Get a Bridge Loan as a Homeowner
Bridge loans are often the only financing option in many circumstances. One of the most common reasons for getting bridge loans is for the purchase of a new home. Homeowners looking to purchase a new house who cannot afford a downpayment until they sell their existing home can take a bridge loan and pay it back when their home sells.
Depending on the housing market, it may take some time for a homeowner to find a buyer for their current home. In the meantime, the homeowner may have found a new home they want to purchase and need money to acquire it. If the homeowner does not have a downpayment readily available but is sure that their home will sell within the next 6-12 months, then a bridge loan may be the way to go.
When to Get a Bridge Loan as a Business
Like homeowners, businesses can apply for bridge loans when they need cash immediately for a project or venture. It could be the opportunity to buy goods at a reduced rate or purchase real estate for the business. As long as the company expects to generate enough cash flow to repay the loan and interest, bridge loans can be a practical solution.
If a business knows it cannot afford to pay off the loan in the stipulated time, a more traditional, long-term loan would be a better alternative. A company stands to lose its collateral should it not be able to repay the loan.
Getting a Bridge Loan
Homeowners looking to get a bridge loan can talk to their mortgage providers to see if they provide these. It’s important to note, though, that not all mortgage lenders will provide bridge loans to their customers.
The most convenient avenues for securing bridge loans are through hard money lenders and online alternative lenders. Bridge loans are easier to secure, making them a ready offer from these types of lenders.
Bridge loans, however, come with increased risks. These loans typically have high collateral requirements and can carry high interest rates and other unfavorable terms.
Bridge Loan Pros and Cons
Bridge loans have both advantages and disadvantages, and borrowers need to weigh these carefully before deciding whether a bridge loan is for them. Let’s take a look at a few of the key pros and cons of a bridge loan:
Bridge loan benefits
- Easy to secure
- Provide immediate cash for purchasing a home or keeping a business running
- Provides homeowners or businesses wiggle room to make cash decisions
- Make real estate purchases easier for buyers
Bridge loan drawbacks
- Short-term loans; borrowers only get up to one year to pay back
- High interest rates on loans
- High collateral requirements
- Borrowers can lose collateral if they do not pay back the loan on time
- Higher risk due to short repayment time frame
Paying Back Bridge Loans
Borrowers can service bridge loans in similar ways to traditional loans. A borrower can pay back a bridge loan using monthly payments, along with interest accrued on the loan. This way, the borrower is put on a repayment plan where they pay a portion of the total amount paid, and total interest on the loan is spread out for the number of months the loan is valid.
Alternatively, a borrower can choose to pay back the loan and the accrued interest in a single lump payment. Given that bridge loans are often secured when borrowers are expecting a large amount of money in the immediate future, they may prefer to forego a monthly repayment plan in favor of this.
So if the stipulated amount for the loan repayment is six months, the borrower can decide to pay a lump sum of the loan amount and interest at the end of the loan term. In addition, the borrower may choose to repay the loan once their expected funds arrive, which could be the sale of a house or a business securing financing/funding.
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