Finance

Pros and Cons of Bridge Loans

December 10, 2021

Are you looking to purchase a new home before you’ve closed the sale of your existing home?

If so, coming up with the down payment can be tricky. For this reason, some homeowners decide to take out short-term bridge loans to cover the purchase of the new property before the old house can be sold.

But is that a wise decision? Are there better bridge loan alternative options available for people in this scenario?

Today, we’ll discuss the pros and cons of bridge loans.

How Does a Bridge Loan Work?

Also known as a gap loan or swing loan, bridge loans are short-term secured debt, meaning they are backed by collateral—in this case, your home.

Bridge financing provides homeowners with financial flexibility they might need to capitalize on short-term opportunities, bridging the gap between the real estate sale of their current home and the purchase of a new one. These short-term loans can be leveraged to purchase assets or cover obligations until a long-term loan can be obtained.

Because they are meant to be short-term loans, they typically will carry high interest rates (8%- 11%) and a short loan term (6-36 months). Naturally, this is more expensive than most conventional loan options. How expensive your loan will be depends on your financial situation and credit score.

Pros of a Bridge Loan

Common benefits of a bridge loan include:

Ability to make a large payment – Many homeowners don’t just have liquid funds to make a hefty down payment on a new house. With a bridge loan, you can leverage your home’s equity to present a stronger purchase offer.
Access to quick cash – In the current climate, some homes are only on the market for a few days before they sell. Would-be buyers may need to access cash at a moment’s notice. You can get approved for a bridge loan much faster than a traditional loan. It may take a matter of weeks, if not days.
No income needed – People who are self-employed, seniors, or retirees will often need to provide proof of income when taking out a loan. But with bridge loans for seniors and all other groups, no such proof is necessary, since the house is used as collateral.

Cons of a Bridge Loan

In most cases, the drawbacks of a bridge loan tend to outweigh the potential benefits. Cons include:

High interest rate – Because it’s temporary and not tied to income, a bridging loan is expensive. Bridge loan financing comes with an interest rate that is much higher than a traditional mortgage, home equity loan, or HELOC.
Fees – In addition to the high interest rate on the loan itself, simply applying for the loan can be a costly process that typically ranges from 1.5% to 3% of the loan. As the Balance notes, bridge loan fees on a $10,000 loan might include fees and closing costs like the following:
- Administration fee – $850
- Appraisal fee – $475
- Escrow fee – $450
- Title policy fee – $450+
- Wiring fees – $75
- Notary fee – $40
- Loan origination fee – 1% of the total loan amount
You need equity, and a good credit score – Most bridge loans require that the borrower have at least 20% equity in their home and a strong credit score. If you have a low credit score, you may need to search for bad credit bridging loans.
Loan exclusivity – Some bridge loan lenders will only provide a bridge loan if you agree to also use them as your lender for the next mortgage.
Two homes – If you purchase your new home before selling your old one, you will still have to pay for the mortgages and expenses on two houses instead of one. And if you’re unable to sell your existing property ~~one~~, that could lead to a foreclosure.

Is a Bridge Loan a Good Idea?

The answer to this is that it depends. For many would-be borrowers, a bridging loan is a high-cost, high-risk temporary solution.

Yes, it can give you breathing room in a tight spot. But it could also backfire disastrously.

Generally speaking, it’s better to wait and sell your old home than to apply for gap financing. Not to mention, there are superior alternatives to bridge financing, such as a home equity line of credit (HELOC).

But even a bridge loan vs HELOC pales in comparison to sale-leaseback solution.

Sale-Leaseback—the Alternative Solution to Bridge Loans

Bridge loans are a potential temporary financing solution for individuals with good credit and accrued home equity. But why would you willingly take on the increased risk and higher fees when there’s a better option available?

Sale-leaseback solutions give you access to the cash you need without the hassle of moving into a temporary home or acquiring another loan. All you do is sell your home and convert the home equity to the cash you need to purchase your next home. The best part is that you can lease your current home back until you are ready to move to your next one.

It’s the perfect way to bridge the gap between your previous home and your future home.

Key Takeaways

Are you looking to purchase a new home before you’ve closed the sale of your existing home? Coming up with the down payment can be tricky, but we have a solution. If you are still unsure of alternative options to securing your down payment after reading this article, consult a financial advisor to discuss your options.

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