What Is It & How Does It Work?
While real estate is often a significant investment, it also often requires you to move quickly to obtain great properties. Moving quickly, however, can be difficult, especially if you’re working as an investor and you have funds tied up in other properties.
To move on strong opportunities as soon as they present themselves—and with cash offers that can set you apart from the competition—having convenient, fast access to short-term funding as opposed to a traditional loan can be a game-changer.
A bridge loan can present that opportunity.
What is a Bridge Loan?
A bridge loan—also known as a swing loan—is a short-term financing option that is meant to serve as a source of funds until the buyer either secures permanent financing or eliminates some specific existing debt. The debt repayment period typically lasts between six months to a year.
Conventional buyers use bridge loans to purchase a new home before selling their existing home. While some investors may use a bridge loan for something similar when offloading one property in favor of another, they may also use a bridge loan to pay off an existing property or other debt obligations to receive funding for another. Or they may use it to help with a down payment.
When Are Bridge Loans Used?
Bridge loans are most often used in real estate by sellers who need to relocate before they’re able to sell their home. They’re also regularly used by real estate investors for a variety of reasons. Investors often use short-term funding from bridge loans to do the following:
- Pay off or reduce the debt load of an existing property to invest in a second property
- Access capital to either purchase a new property, either purchasing it in full or with a down payment
- Use a bridge loan to purchase an investment property in addition to their existing mortgage loan that will yield significant profit quickly
How Does a Bridge Loan Work?
Knowing how a bridge loan works is important in deciding if they’re right for you.
Bridge loans are a type of specialty nonmortgage financing that leverages equity in an existing property or investment, most often a home, to offer quick, short-term access to capital. It’s designed to cover a transitional period. In most cases, buyers temporarily may have a mortgage on their first home, a mortgage on a second property, and the bridge loan itself.
For this reason, bridge loans tend to require a low debt-to-income ratio, a high credit score, and a certain percentage of equity in your property. In many cases, banks may require a minimum of 20% equity in a home before you’re eligible for a bridge loan, as that will be used as collateral to secure the loan.
While terms and conditions of bridge loans vary significantly based on a number of factors— including the requested loan amount, the lender you choose, and your specific situation—you can expect that it will cover a period of six months to a year.
Some bridge loans may require you to make set payments every month, while others may have a specific payment schedule requiring set amounts to be paid at the beginning and/or end of the loan period in a lump sum payment. In these cases, you may have interest-only payments month to month, and then the lump sum payment at the end of the loan term.
Because bridge loans are very short-term loans compared to traditional mortgages or other long-term loans like home equity loans or home equity lines of credit (which may have a draw period of around 10 years and a 20-year repayment period), they’re likely to have higher interest rates and therefore, higher monthly payments.
The good news is that they also have much faster application-to-close processes. You may be able to obtain a bridge loan approval—and funding—in as little as 10 days with some lenders.
Benefits of a Bridge Loan for Investors
There are plenty of bridge loan pros for real estate investors.
They allow for flexibility
If you’ve got money tied up in one property and need cash to close on an investment quickly or for a down payment, a bridge loan can offer that flexibility. They’re an outstanding temporary option, offering temporary financing while you secure permanent financing, reducing cash flow concerns significantly.
They are fast
Bridge loans can be completed and funds can be in your account in as little as 10 days. That’s much faster than some other types of loans, including home equity loans or lines of credit, which can take anywhere from two to six weeks on average for approval. This is a huge advantage in real estate, where you need to move quickly.
There are plenty of bridge loan lenders
Plenty of credit unions, big banks, and online lenders offer bridge loans, giving you flexibility and the ability to shop around for rates if you plan ahead.
Avoid private mortgage insurance
If you don’t have the cash to put down the down payment you want on a property, you could easily end up with PMI, which is just an extra cost, and many investors prefer to avoid it when possible.
Relatively low closing costs
While closing costs vary significantly by the lender offering the bridge loan, you can expect to pay between 1.5% to 3% in closing costs. This is less expensive than other options, including refinancing a mortgage, which you may do to remove PMI and could cost closer to 2% to 6% in closing costs.
Disadvantages of a Bridge Loan for Investors
Just as there are pros of bridge loans, there are also some cons of bridge loans that real estate investors want to consider. These include the following disadvantages that bridge loans typically involve.
High interest rate
Because bridge loans are not a long-term financing solution, you’ll pay interest rates that are much higher than you would with a traditional mortgage (or even second and third mortgage payments, depending on your properties). Bridge loan interest rates increase and decrease like all other rates, but average around 6% to 10%, based on the prime rate.
Short repayment period
A short repayment period can be an advantage, but it can also be a negative. Short repayment periods mean not only higher interest rates, but a higher monthly payment, and if you’re paying off a significant part of the loan in a lump sum balance (especially since this is at least a second loan), that may be difficult to pay off for some investors.
It’s only temporary
Bridge loans are meant to be used for bridge financing during a transitional period. It’s very likely that you’ll need to find a long-term solution for financing, potentially including a second mortgage if needed.
They may be difficult to obtain for some investors
Bridge loans require high equity in your home, low debt-to-income ratios, and a strong credit history. Not everyone will be eligible, especially if you’ve already got an expansive portfolio of investment properties with loans attached.
It will impact your debt-to-income ratio
Once you take out a bridge loan, it will impact your debt-to-income ratio until you pay it off. That ties up more of your home equity, so you likely won’t be able to apply for other financing (like a home equity line of credit, which some investors may use to access funding to repair, remodel, or secure additional properties).
It requires collateral
Any time you’re using collateral to secure financing, there’s a risk. You could lose not only the new investment property, but the first home, too. While well-planned investments typically prevent this from happening, there’s always a risk—especially if the market takes a turn and a home sells for much less than expected.
How to Get a Bridge Loan
Interested in using a bridge loan as a short-term loan option?
The first thing you need to do is assess whether it’s a fit for your needs and your existing situation. To do this:
- Consider how much equity you likely have in an existing property based on your first mortgage and what you think it’s valued at, based on current market trends.
- Check your debt-to-income ratio and make sure that you’ll be able to accommodate the bridge loan.
- Determine how long you expect to need the gap financing for and what you can afford to pay monthly; you can use our Real Estate Investment Calculators to assess cash flow, potential ROI of new properties, and profit on potential flips.
Once you’ve done this, start researching vendors. There are plenty of options, including credit unions, big-name banks, private lenders, and online lenders. Most will list basic loan terms online, but you’ll need to talk to a lender directly to get the full details. If possible, shop around to find the lowest interest rates and the best loan terms that work for your needs.
After choosing a lender, apply. Almost all lenders have secure online loan application processes. Your finances and credit history will be reviewed, and depending on the lender, they may require a property appraisal. You’ll be given a detailed loan overview that will include your interest rate and repayment schedule.
Loan approval may happen in as little as 10 days, depending on the loan officer. Funding will arrive in your account, and you can start investing!
Bridge Loan Considerations for Investors
If you need to borrow money to secure a new property or help make a down payment, bridge loans are a solid option for real estate investors. You should, however, consider your needs and whether bridge loans are right for your real estate transactions.
Home equity lines of credit, a home equity loan, construction loans, short-term loans, and long-term loans are all bridge loan alternatives for real estate investors. They have varying pros and cons, ranging from extended draw periods, different repayment periods and terms, and different interest rates. Some may also have restrictions about how you use the funds, while others don’t.
Take time to research your options, ideally before you start prowling for new investments, so that you’re ready to act quickly. However, when in doubt and when you need funds fast, bridge loans can be a great option.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.