The Quick and Easy Guide to Bridge Loans

Senior woman checking the pros and cons of bridge loans

Key Takeaways

  • Bridge loans are short-term financing options that borrowers use to fill gaps in capital needs.

  • Compared to other financing options, bridge loans generally have higher interest rates, additional fees, and other terms – such as balloon payments and prepayment penalties.

Bridge loans can be versatile – yet sometimes misunderstood – financing choices for borrowers in both personal and business settings. For example, borrowers may not be familiar with the concept of a balloon payment, which is a common feature of a bridge loan.

What Is a Bridge Loan?

A bridge loan is a common type of short-term financing that both individuals and businesses use for quick access to capital. The usual length of a bridge loan is 6-12 months, but can be shorter or longer depending on the parties and the intended use of the loan proceeds. The terms that lenders offer for bridge loans will vary, but generally include the following:

  • Repayment in the form of principal and interest

  • Collateral (i.e., a security interest) with the borrower’s assets, such as a house or other property

The repayment timeline for a bridge loan is different than that of other loan arrangements. Instead of monthly payments like you would have with a mortgage, a bridge loan may have a balloon-payment structure. A balloon payment is a repayment method where the borrower does not make incremental payments slowly over time, but rather makes one large payment on the loan’s maturity date. Additionally, bridge loans may have prepayment penalties. These are fees the lender charges if you pay off the loan early.

The Purpose of a Bridge Loan

As the name suggests, the purpose of a bridge loan is to fill a gap in financing. In a commercial setting, for example, a bridge loan might provide the funding to cover the cash flow needs of a seasonal business during off-season operations. A bridge loan is also commonly found in a few real estate contexts, including the following.

House-Flipping Projects

House flipping is the purchase of a property with the intent of reselling it after various renovations or improvements.

House flippers often use bridge loans to finance the purchase of the project, with the expectation they will resell it in the next few months. Lenders in these situations will usually require collateral (often a personal residence) and a personal guaranty if the house flipper uses an LLC or other entity for its operation.

Bridge loans are a common solution to the problem of needing to buy a house before you sell your current home.

Buying a New House

Another real estate-related purpose for a bridge loan is if you are selling your current home and buying a new one. Many homeowners rely on the equity from their current house to cover the down payment for the new home. The problem arises if you want to purchase the new house before selling the current home.

To address this issue, lenders will offer bridge loans to homebuyers. The bridge loan allow thems to close on their new home, and then use the proceeds from their old home’s sale to repay the bridge loan.

Prospective homebuyers may use a bridge loan to purchase a new home before selling their current property.

The Pros and Cons of Bridge Loans

All financial decisions, such as a loan, require a careful evaluation of advantages and disadvantages. Advantages of a bridge loan include:

  • application process and closing timeline; you’ll usually receive funds faster than with other loans

  • Short-term financing relief when you have limited options or lack necessary capital

  • Balloon payments may alleviate immediate repayment burden (however, interest will still accrue)

Disadvantages include:

  • Higher interest rates than other loans, so you’ll pay more over the long term

  • Risk of foreclosure in the event of a default

  • Additional fees for processing the loan (e.g., origination, escrow, closing)

The higher interest rate of a bridge loan generally increases the overall cost of the loan, as demonstrated through examples of how interest rates affect various loan types.

Learn About Other Financing Options

Existing homeowners who have accumulated equity in their homes may want to consider a home equity agreement (HEA) to access that equity. A HEA is a transaction between a homeowner and a HEA provider such as Unlock Technologies.

In a HEA, the homeowner sells a percentage of their ownership interest to the provider in exchange for cash. The homeowner could use the cash for home improvements, consolidating debt or any of the uses of a bridge loan described above. The standard length of a HEA generally is 10 years, which is the length of time in which a homeowner must repay the amount received under the agreement.

Repayment usually happens in one of two methods:

Sale proceeds: The homeowner sells the home and provides Unlock with proceeds that are proportionate to its percentage of ownership.

Buyout: Rather than sell the home, a homeowner may also buy out Unlock by paying the amount of its ownership interest based on the home’s current market value. An independent appraisal is generally used to determine that amount. This can happen any time in the term of the agreement.

When comparing your financing options as a homeowner, consider the value of a HEA. You can enter a few details through Unlock’s online form to see if you are eligible. Homeowners generally need a minimum credit score in the 500s to qualify.

Contact Unlock Technologies today for questions about how HEAs work, and can work for you!