Whether you are new to the real estate market, or you have been in it a while, you may not have heard the term “bridge loan”. So what does this mean and when would you potentially need to use it when you are looking at financing real estate?
What is a Bridge Loan?
A simple definition of a bridge loan is a short term loan which provides temporary financing until a permanent form of financing can be obtained. This type of loan can be done quickly and is typically secured with real estate.
An example of someone getting a bridge loan would be purchasing a second property but the first one has not sold yet. This can be a common issue when buying real estate but depending on the market or property, you are not willing to give up the second property or do not want to make that purchase contingent on the first one selling. As a result, you will get some quick financing and pay it back once the first property has been sold. You can do this in reverse by securing the funds with the new property and then paying it back when the first sells.
A great feature to note about bridge financing is that it is not just for real estate investing but it can be used by home owners as well. This is a great option to have when you do not want to make your purchase contingent on anything such as financing or a house inspection. You will have the funds you need for your purchase and then be able to pay them back when the proceeds from your sale. With that said, you do need to have a plan in place to pay these funds back in order to qualify for this type of loan.
Should You Use a Bridge Loan?
While the option of using a bridge loan when you are buying real estate is attractive, there are a few things to consider. Interest rates are typically higher but for the most part, you are not borrowing these funds for long so this should not add up to a lot. You need to have quite a bit of equity in your current property in order to qualify regardless of whether this financing is for personal or business.
If you are still having issues determining if a bridge loan is for you, consider this example.
You are looking to purchase a new home. You cannot afford a down payment for a second property. You have a few things to consider. Sell your current home and then hope you can find and move into a new home before you have to be out of property one OR you can sell your home and move into temporary housing until you find a new home.
To avoid having to move twice and all the fees associated with that, you can obtain a bridge loan which will cover the down payment on the second home. You can move once into your new property and then sell your first home and pay off the bridge loan. While there is some extra financial stress with this process, it can be a good option.
As with any loan, it is important to be aware of any fees you are going to encounter. The biggest one is the interest and there are a variety of factors which can affect the interest rate such as the type of property you are dealing with, the expected length of the loan and the credit of the borrower. If the lender feels there is a higher risk, the interest rate will be higher. Less risk, the interest rate will be lower.
Residential vs Commercial
When it comes to real estate financing, you can get a bridge loan for any type. But how it works is different for residential and commercial properties. For instance, for a residential home, you can typically borrow up to 75% of the current value but for commercial property, you can typically only borrow up to 65%. A large part of this is that commercial property can be more difficult to value and to sell. It is much easier to value a home due to many comparable properties.
As with any type of loan, the less you need to borrow against the value of the property, the better rate you will get. Someone who is borrowing 10% of the value is going to a better rate than someone is borrowing 50%. Lenders are always cautious which interest rates reflect. More risk, higher interest rate.
Advantages of a Bridge Loan
– Ability to use the equity in a current property to finance a new property
– Quick turnout to get financing
– Can get short term financing as bridge loans are designed to be less than a year
– Gives the ability to make an offer on a new property without selling the existing property first
– It can be easier to qualify for a bridge loan than a standard loan which can be a large benefit for someone with debt issues. You do not have to satisfy the same conditions of a standard loan such as income.
Disadvantages of a Bridge Loan
– Higher interest rates and transaction costs
– A prepayment penalty may be accessed if it is for a business; this typically cannot be applied to an owner occupied property due to regulations in place.
– If your original property doesn’t sell, you may be paying for this loan longer than you expected
Finding a Lender
When it comes to finding a lender for financing real estate, there are a few things to consider. A bridge loan typically is not given by a bank but from private money lenders. You can start by asking your realtor or anyone else you know who has used this type of financing for a referral. You could talk to your bank and see if they do provide this service or if they can refer you to someone. If nothing else, you can always turn to the internet and ask on social media or use a search engine.
While using this type of financing for real estate investing is not always the best choice, it can be helpful in a variety of situations. It is always best to know your options.