When you need to improve your cash flow during a transitional period, a bridge loan may be a good option for your business. They are used to put more cash in your pocket, pay off existing debt, or finance the purchase of a new property. Just like other forms of financing, bridge loans have advantages and disadvantages. In this blog, we’ll explain how to determine if a bridge loan may be beneficial for your business.
What is a Bridge Loan?
A bridge loan is a type of short-term financing that can provide funding until an individual or business can secure permanent financing or remove a current debt. These loans are short-term, typically lasting 6 months to 1 year, and are typically used for real estate transactions.
When purchasing a new property, ideally you want to wait until the current one is under contract. Then, you can use the funds from that sale to purchase the new one. However, this isn’t always an option. In this case, you can use a bridge loan to purchase the new property and then pay it off when the current one sells.
How Does it Work?
A bridge loan is typically used by a seller that finds themselves in a tight spot or needs to quickly relocate. The terms and fees vary greatly between lenders and even individual transactions. In addition, costs and payment structures vary as well.
Some of the most common reasons to obtain a bridge loan include:
- Inability to come up with a down payment on a new property without selling your current one
- Need to quickly secure a new property
- The closing date on the new purchase is scheduled after the closing date for the sale of the current property
- Need to secure a new property before selling a current one
- Sellers prefer a contingency-free offer
There are two primary options for business owners who are seeking a bridge loan:
- Use the funds as a second mortgage to put a down payment on the new property before selling the current one
- Pay off the mortgage on the current property and put the remaining funds toward the down payment on a new property
Bridge loans typically:
- Offer 6 to 12-month terms
- Secured using the current property as collateral
- Issued by lenders who are financing your new mortgage as well
- Interest rates vary, with rates slightly above prime
Applying for a bridge loan is similar to applying for a conventional mortgage. The lender will look at various factors, including debt-to-income ratio, credit score, and credit history.
In most cases, you can borrow up to 80% of the loan-to-value ratio on the property. This means you’ll need at least 20% equity in your current property to qualify for a bridge loan, along with the other qualifications listed above.
Advantages & Disadvantages of Bridge Loans
Bridge loans have advantages and disadvantages, just like other forms of financing:
- Provides you with the ability to purchase a new property before selling your current one
- Allows you to make an offer on a new property without contingencies
- Provides additional funds in case of a sudden/time-sensitive transition
- Offers a short-term solution for periods of uncertainty
- Some loans offer no payments for the first few months
- Potential for interest-only or deferred payments until the current property sells
- Interest rates and APR are higher
- Require 20% or more equity in your current property
- Many lenders only offer bridge loans if you commit to using them for your new mortgage
- May own two properties at once, meaning you must balance two mortgages
- Difficulty selling current property may result in future issues or possibly foreclosure if you’re unable to pay
You can obtain bridge loans through a variety of lenders including banks, credit unions, and alternative lenders.
Alternatives to Bridge Loans
There are several alternatives to bridge loans, including:
- Home equity loans
- Home equity line of credit (HELOC)
- 80-10-10 loan
- Personal loan
If you find yourself in a situation where you need to obtain a new property before selling your current one, a bridge loan may be helpful. However, it can be costly and increase your overall debt load. The best strategy is to sell your current property before acquiring a new one. If you are interested in learning more about bridge loans and alternatives, contact Point High Finance today.