What is a Bridge Loan? How Does a Bridge Loan Work?

Written by Posted On Friday, 26 February 2021 09:15
What is a Bridge Loan? How Does a Bridge Loan Work? What is a Bridge Loan? How Does a Bridge Loan Work?

What is a Bridge Loan?

Bridge loans for real estate are short-term loans that allow property owners to borrow against the equity within their existing property for the purpose of purchasing a new property. After the new property has been purchased the previous property is sold. The sale of the previous property pays off the bridge loan. A bridge loan can be used for residential real estate and commercial real estate. Bridge loan borrower could be a homeowner purchasing a new home or a real estate investor purchasing a new property.

Incorrect Usage of the Term “Bridge Loan”

Borrowers may incorrectly use the term bridge loan to refer to any temporary or short-term loan. It is common for the term “bridge loan” to be used to describe any temporary financing but this isn’t an accurate definition.

Definition of Bridge Loan

So then, what is a bridge loan? A common definition for the term “bridge loan” is a short-term loan against the borrower’s existing property which is used to purchase a new property. Once the new property is acquired, the original property is then sold to pay off the bridge loan.

Bridge loan financing “bridges the gap” between one property and another property.

How Does a Bridge Loan Work? Bridge Loan Example

A homeowner lives in a home they currently own. The homeowner wants to move to a new home but doesn’t have enough cash for an all-cash offer or sufficient down payment. The homeowner does have significant equity in their current home. Selling the home and using the sales proceeds to purchase the next property would possible but it may be inconvenient and expensive.

Option 1 - Moving without a Bridge Loan

The homeowner lists their home for sale to obtain the needed cash to purchase a new home. Once the sale of the home is then completed, they move to a rental property temporarily and start looking for a new home. After the homeowner completes the sale of a new home, the homeowner moves for the second time, from the rental property to the new home.

Option 2 - Moving with a Bridge Loan

The homeowner continues to live in the current home as they obtain the bridge loan. After the bridge loan is funded, the homeowner takes the bridge loan proceeds and purchases a new home. The homeowner then moves into the new home and sells their previous home. The sale of the previous home pays off the bridge loan.

Where to get a Bridge Loan? Who Offers Bridge Loans?

Bridge loan lenders are commonly private hard money lenders. Some conventional lenders such as banks and credit unions may offer bridge loans also. Conventional lenders typically prefer to long-term loans. Private hard money lenders focus on providing short-term loans, including bridge loans.

A residential bridge loan from a hard money lender has interest rates that are higher than conventional loans. The rates are higher but hard money lenders can provide a faster approval and funding process.

On an owner-occupied hard money bridge loan, the approval and funding process should take 2-3 weeks. The same type of loan from a bank may take 30-45 days or longer. A bridge loan on investment property, can be approved and funded by a hard money bridge loan lender within 5 days if needed.

Bridge Loans are Flexible

Hard money bridge loans can be used in different ways to help the borrower accomplish their current goals. The existing real estate owned by the borrower can serve as the collateral for the bridge loan. A bridge loan can also be used in reverse order and have the bridge loan secured by the new property being purchased. A bridge loan can also be secured by both the existing property and new property being purchased.

Owner Occupied Bridge Loans – Exemption of Ability to Repay

Bridge loans with terms of 12 months or less are exempt from the Ability to Repay Rule. The current home that will be sold once the new home is secured will be the repayment for the bridge loan. Income documentation from the borrower isn’t analyzed as thoroughly as for conventional long-term owner-occupied loans.

Not needing to provide proof of income verification is valuable for certain persons such as:

- self-employed borrowers

- retirees and seniors on fixed income

- individuals without sufficient income in the past couple years

Qualifying for a Bridge Loan

Qualifying for a bridge loan from a hard money lender is fast and easy. The bridge loan lender will provide an application the borrower must complete. The borrower must have sufficient equity in their property relative to the loan amount they will need. They must also have enough cash in the bank to cover the monthly mortgage payment and other real estate holding costs for the duration of the bridge loan.

Because the Ability to Repay Rule does not apply to bridge loans, income documentation and qualifying with a debt to income ratio is not as required to meet the current federal regulations. If the borrower has sufficient equity in their current property, many hard money bridge lenders will be able to overlook poor credit and other issues on a borrower’s record including short sales, loan modifications, bankruptcies, foreclosures or a deed in lieu.

RELATED: How long does it take to get a bridge loan?

Loan to Value Ratios for Bridge Loans

Bridge loans can have a loan to value up to 70-75% of the current property value. Property with an existing mortgage will need to be refinanced by the new bridge loan so the lender can have their loan in 1st position.

RELATED: How to Qualify for a Bridge Loan

Rates and Fees for Bridge Loans

Lenders providing bridge loans are often hard money lenders. Some conventional lenders such banks and credit unions provide bridge loans also. Hard money lender bridge loan rates are commonly in the range of 8-10%. The specific rate will depend on various factors including the requested loan to value ratio, strength of the borrower, lender, location and specific property.

Hard money bridge loan lenders typically charge 2-3 points for the origination fee. 2 points would be a fee of 2% of the loan amount. Borrowers are advised to ask upfront about any additional fees that may be added by the lender.

Bridge loan rates and fees from hard money lenders may be higher than conventional bank loans, but the quickness of the approval and funding process are often worth the added expense. Since bridge loans are for 12 months or less, borrowers only have the higher interest rate for a few months. The total interest paid is not typically significant.

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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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