Pros and Cons of Bridge Loans

Written by Posted On Friday, 26 February 2021 09:16
Pros and Cons of Bridge Loans Pros and Cons of Bridge Loans

Bridge loans are short-term loans in which a property owner borrowers against the equity in their existing real estate. The intention is that the borrower will purchase new real estate. After the the new real estate has been secured, the previous property will be sold in order to pay off the bridge loan.

Bridge loans are useful financing tools for homeowners and real estate investors with sufficient equity within their property. Prior to applying for a bridge loans, it is necessary to understand the pros and cons of bridge loans.

Bridge Loan Pros

PRO – Avoid Moving Twice

If the homeowner obtained a residential bridge loan they would only need to move one time. Once the bridge loan is funded, the homeowner would have the needed funds to purchase the new home. After the new home is purchased, the homeowner moves and sells their previous home.

If the homeowner decides to first sell their current home to access the equity in the property there would be additional steps. The homeowner must move somewhere temporarily and sell their home. When their home sells, they would use the proceeds to purchase their new home. Once they have completed the purchase of new home the homeowner would then move from the temporary housing to the new home.

PRO – Access equity quickly without selling

The purpose of a bridge loan is to borrow against the equity in an existing property in order to purchase a new property. Hard money bridge loans can be approved and funded very quickly.

Bridge loans for investment property can be funded in as few as 3-5 days if needed. Owner-occupied bridge loans take 2-3 weeks as there are additional federal regulations that all lenders must follow. Hard money bridge loan lenders typically provide approval and funding much faster than conventional lenders who offer bridge loan financing.

PRO – Present a stronger purchase offer

Homebuyers will occasionally present a purchase offer that is contingent on their current residence selling before closing the new home. Buyers must submit this type of offer when they don’t have cash on hand for a sufficient down payment or all-cash offer and need the equity in their current home to complete the purchase of the new home.

This type of offer may work in some situations, but from the seller’s point of view this type of offer is weak due to the inherent risk. There is no guarantee the buyer’s property will sell quickly and at the estimated price. Any other comparable offer without a contingency to sell an existing property would likely be accepted instead.

During a rising real estate market, purchase offers with contingencies to sell are not likely to be accepted or even responded to. A buyer who chooses to obtain a bridge loan against their current home and present an offer with an all-cash offer or sizable down payment has a much better chance of their offer being accepted.

Bridge loans can help a buyer completely change their situation and take a purchase offer from very weak (contingent on sale of current home) to very strong (all-cash offer).

PRO – Receive bridge loan approval after being denied by banks

Hard money bridge loan lenders are asset-based lenders and are most concerned with the value of the real estate as well as the equity the borrower has in the property. Hard money bridge lenders are able to lend to borrowers with bad credit and issues including foreclosures, discharged bankruptcies, loan modifications and short sales if the borrower has significant equity within their real estate.

Institutional lenders like banks are much more concerned with a borrower’s income history and credit scores. Banks will see any issues on a borrower’s record as a red flag and probably deny the bridge loan request.

PRO – Attain a bridge loan against currently listed real estate

Hard money bridge loan lenders are in the business of providing short-term loans and will provide bridge loan mortgages for real estate that is currently listed for sale.

Most institutional lenders will not consider a loan against a property that is currently listed for sale. These types of lenders do not want to go through the process of approving, underwriting and funding a loan only to have the loan be paid off within 2-3 months.

PRO – Income documentation not required

The current federal regulations require the borrower to provide income documentation for owner-occupied loan. The lender is required to calculate the borrower’s debt to income ratio and make sure it remains in a reasonable range.

Borrowers without sufficient income documentation cannot qualify for an owner-occupied loan because of the Ability to Repay Rule. Both conventional lenders such as banks and credit unions and private hard money lenders must comply with this rule.

The Ability to Repay Rule does not apply to bridge loans as there is special exception. The sale of the existing property that will be sold once the new property acquired serves as the repayment for the loan.

Bridge loans may be the only type of owner-occupied financing available for self-employed individuals, seniors, retirees, and those without income (but have equity in their home).

Cons of Bridge Loans

CON –Higher interest rates

Hard money bridge loan lenders have higher interest rates than conventional lenders. The fast approvals and funding provided by a hard money bridge loan lender generally justify the higher rates for the borrower.

Hard money bridge loan rates are higher compared with conventional loans, but the borrower will only have the bridge loan for a very short term (12 months or less). The borrower may only make a few monthly payments before the bridge loan is paid off. The overall interest paid on the bridge loan is not likely to be substantial.

CON – Higher transaction costs

Origination fees for hard money bridge loans are typically in the form of points, which are likely to be in the range of 1.5-3 depending on the lender and other factors of the loan scenario. Borrowers also will have to pay for standard real estate transaction fees including title insurance, escrow, notary and recording fees.

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Jeff Hensel

North Coast Financial, Inc. is a California hard money lender with over 37 years of experience specializing in various types of hard money loans including probate and estate loans, investment and rental property loans, bridge loans, fix and flip/rehab loans, purchase loans, cash out and refinance loans and other hard money loans with California real estate as collateral.

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