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Bridge Loans: Definition, Requirements & Example

Instructor: Ian Lord

Ian is a real estate investor, MBA, former health professions educator, and Air Force veteran.

A bridge loan can provide a valuable financing option for people who may not be able to sell their current home before they need to purchase a new one. Let's take a look at bridge loans and some of the requirements to apply for one.

Bridge Loan

Jerry's job requires him to relocate and move a few hundred miles away. He will need to sell his house and buy another one closer to work. Considering factors such as how quickly he needs to move and how fast homes in his market sell, Jerry will most likely need to buy a new house before his current one is sold. Since there isn't a guarantee that he will be able to sell his current home and use the equity to make a down payment on the new house, a bridge loan might be a solution that allows him to make a purchase before selling the old house.

Definition

It can take a bit of time for a person or business to secure long-term financing. In the short-term, these people might need access to funds to make a deal happen. Jerry is caught in a situation where he can't count on selling his home quickly enough to be able to buy a home in his new location. A short-term loan known as a bridge loan can be used to provide cash flow until a more permanent lending solution can be put in place. Jerry can make the mortgage payments on the two houses for a short time until the old house sells, but needs money to make a down payment on the new property. The bridge loan funds can be used to make a down payment for the new house.

Many lenders will overlook the fact that Jerry might have to make two mortgage payments for a short period of time when a bridge loan is involved because of the collateral. Bridge loans are typically secured by collateral, such as a piece of real estate or other valuable asset that will be forfeited to the lender if the loan is not repaid. With two mortgages, a borrower's debt-to-income ratio might indicate that they can't afford to buy a second house. The bridge loan provides Jerry with the cash down payment, which makes it affordable in the short-term for him to make both monthly mortgage payments until he has time to conclude both real estate transactions.

Bridge loans are short-term, usually made for periods not exceeding one year, and carry high interest rates compared to long-term debt products, such as mortgages. The borrower may not have to make payments for a few months, but the loan will accrue interest during that time.

Requirements

In order to get a bridge loan, a lender will require an application and documentation similar to that of obtaining a mortgage. Jerry will need to have his house appraised to determine the value of the house, pay for title policy insurance, and pay an origination fee. The origination fee is an upfront payment made to the lender to process a new loan application and may run 0.5% to 1% of the value of the bridge loan. Most lenders will not underwrite a home equity loan on a property that is listed for sale, but these additional fees for a bridge loan offset the lender's risk.

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