Are you looking to buy a new house but running on a tight budget? Are you running a business and waiting for that long-term loan to clear?
Thankfully, there are different financial tools that can help. Bridge loans, for example, are one of the most popular choices among prospective home buyers and business owners.
A little over a decade after the United States housing crisis, bridge loans are slowly regaining traction among home buyers. Back in 2017, bridge loan applications in Cleveland jumped 137%.
But what is a bridge loan? How come there are people who are afraid of applying for such a loan?
Let us try to zoom in on the bridge loan and understand how it works. Find out the pros and cons of bridge loans and how they can benefit you by reading below.
What Is a Bridge Loan?
Before we head on to the benefits it offers, let us first define what a bridge loan is. It is a type of short-term loan that works by “bridging” the gap between one loan and another.
For example, you are eyeing a new home but do not have enough funds. Instead of waiting for your current home to sell, you can apply for a bridge loan and enjoy temporary financing for the new house.
You apply for a bridge loan and take it against your current house. You will then use that loan to cover the down payment for the new house.
You can also apply for a bridge loan, which you can use in your business. As we mentioned earlier, a bridge loan can cover your financial requirements while you wait for a long-term loan to clear.
Let’s say that your original loan takes about 5 to 6 months to clear. Since your business needs money to run uninterruptedly, a bridge loan can be the source of your operational expenses during the 6 months of wait.
Do note that bridge loans come with different terms. They range from duration to penalties; valuations and markets, among others. Check out this page for more information on the different bridge loan terms.
The Key Requirements
Like in any other type of loan, bridge loan lenders impose strict requirements to their prospective borrowers. Let’s discuss each one of them:
1. Excellent Credit Standing
This is the first requirement lenders will look at when you apply for a bridge loan. Generally, your credit standing is “exceptional” if it hits the score of 800 and beyond. A “good” credit score, on the other hand, is anywhere between 670 and 739. If your score is below 580, then it is “poor.”
The higher your credit score is, the bigger the chances of the bridge loan lenders approving your application.
2. Home Equity of 20%
Lenders will also require you to have significant home equity. This pertains to the value of your house less the balance that you owe your mortgage.
Lenders of bridge loans require borrowers to have at least 20% home equity. This means that they will approve applications at 80% value of both the proposed mortgage and the current mortgage of the homeowner.
If you are eyeing a house worth $500,000 and your current home is worth $300,000, you can only borrow a maximum of $640,000. The amount is 80% of the values of the two properties combined.
3. Low Debt-To-Income Ratio
Debt-to-income ratio refers to the ratio of your debt payment against the overall income you make. This is one way for lenders to determine your capabilities of paying your monthly mortgage, as well as your other debts.
If they see that your debt-to-income ratio is high, they will likely have second thoughts on approving your bridge loan application.
These three requirements, alongside other factors, are serious challenges for home buyers. Do not fret, however, if you are struggling in any or all of these three requirements. Slowly work your way up out of the financial hole you are in.
If your credit score is lagging, discipline yourself in terms of spending. Pay off your debts first before acquiring new ones.
The Key Benefits
Let’s take a look at the key benefits you can enjoy from a bridge loan:
1. Purchase Without Restrictions
First and foremost, bridge loans will allow you to buy a house without restrictions. This is because the home seller will no longer worry about your inability to pay. The financing that will come from the loan will cover for the down payment the seller is asking.
2. Save More Time
It also helps you save more time in different aspects. It allows you to a new home while waiting for your old one to sell. Moreover, you can also transfer to your new house over the course of several days, as opposed to moving immediately on the day of closing.
3. No Monthly Payments Required
On top of being short-term in nature, bridge loans also don’t require monthly payments. This applies, however, in the first few months. This lets you prepare for the moving-in process with much ease and less burden on your finances.
Now let’s move over to the cons of bridge loans:
1. Two-Mortgage Payment
Before they grant your application, lenders must determine your capability of paying two mortgages at the same time. This is arguably the biggest challenge prospective home buyers consider.
2. More Expensive
Bridge loans are generally more expensive compared to other types of loans. This is because of the fees and other charges lenders apply on the loans. Additionally, bridge loans also come with soaring interest rates.
3. Extreme Financial Constraints
In a worst case scenario, you may find yourself facing a huge financial burden like never before. This happens when you fail to sell your current home. This means you will have to pay three different loans: your original loan, your bridge loan, and your new loan for the new house.
Learn More About Real Estate and Financing, Today!
A bridge loan is simply one of the many options available. It is best to look at all the other loan types before making a decision.
If this article helped you answer the question “what is a bridge loan?”, check out our other real estate and finance-related articles. We discuss topics from selling your home as-is to understanding the pros and cons of rent-to-own houses, among others.