Bridge Loans as a Short-Term Financing for Homebuyers
A bridge loan is a form of financing offered by banks and companies to individual customers and businesses. Homebuyers often need money for the purchase of a new home while they are in the process of selling their old house. Borrowers also use the money to pay divorce expenses and estate taxes and to save key investment projects from foreclosure. The money can be used to make a down payment. Borrowers have two options for this – a bridge and a home equity loan.
Home Equity vs. Bridge Financing
As a rule, homebuyers benefit from lower interest rates if they opt for a home equity loan. The problem is that borrowers can lose their home in case of default. Bridge financing is another option whereby the applicant’s home serves as collateral. There are many benefits, and one is that this is a short-term loan with a term of 2 months to 3 years. Thus, the customer pays the outstanding balance in several months instead of over 15 – 20 years. The longer the repayment schedule, the higher the risk that the borrower will face financial problems at some point. Another benefit is that borrowers can choose a repayment option and can pay back the loan earlier. There are no prepayment penalties.
Downsides of Bridge Financing
One problem is that financial institutions offer higher interest rates. The reason is the short term over which the loan is repaid. The interest rate may be 10 percent or higher, depending on the financial institution. Banks tend to favor long-term financing options because they earn more money in the long run. Thus, they are not the best place to shop for a bridge loan. One option is to use the services of a mortgage broker who works with different lenders.
Eligibility Criteria
As with other forms of financing, lenders look at the borrower’s credit score and payment history. Collateral is required and can be in the form of a home, real estate, or another valuable asset. Businesses that apply for financing can pledge tangible and intangible assets such as intellectual property, buildings, accounts receivable, and others. Financial institutions may require that business owners reduce their operating expenses. This will make it easier for borrowers to meet their monthly payments. In addition, there are origination fees in the range of 1 to 2 percent of the amount offered.
Financial institutions want to know how and when the loan will be repaid. This requires good budgeting skills and advance planning. Lenders usually require proof of income, including income level, savings, and other sources of income.
Exit Options
In general, borrowers have three options to choose from. One is to pay the full amount while a second option is to apply for another loan (replacement financing). A third solution is to sell the collateral.
Alternatives
Besides home equity and bridge financing, banks offer home equity lines of credit. Borrowers can use the money to make a down payment, for home improvements, and large purchases. Another option is to borrow from a family member or close friend. A third alternative for cash-strapped homebuyers is to borrow from their 401K, provided that there are sufficient funds in it. Financial institutions accept it as a source of payment, and it is a cheaper way to borrow compared to other lending products. A secured loan is another option, and any type will work. Applicants can use insurance policies, bonds, and stocks as collateral. Whatever the solution, it is important to apply for financing before the house is listed for sale.
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