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What is a Bridge Loan?
A bridge loan is a short-term financing option used to purchase assets or cover immediate costs until you are able to secure long-term funding or pay off existing debt. These types of loans are typically used by homebuyers to purchase a new property prior to the sale of their current one. The duration of a bridge loan typically ranges from a few weeks to a few months, although it can sometimes extend up to a year or more depending on the specific terms negotiated between the borrower and the lender.
Who Needs a Bridge Loan?
Bridge loans can be useful for a variety of people. They are a short-term loan that are often used to gap the time between two financial transactions. Here are some of the people who might find bridge loans useful:
- Real estate investors: Bridge loans can be used to finance the purchase of a new investment property before the investor has sold their existing property.
- Homebuyers: Bridge loans can be used to cover the down payment and closing costs on a new home before the buyer's old home sells.
- Developers: Bridge loans can be used to finance the construction of a new development project before the developer has secured permanent financing. They may also be used to fund renovation projects.
The Pros and Cons of Using a Bridge Loan
The pros, bridge loans provide short-term cash flow. An example from Investopedia explains how business owners use bridge loans to cover operating expenses. Similarly, a real estate investor can use a bridge loan to make a purchase before finalizing the sale of their current home. It is a useful option covering short-term financial gaps.
The cons are that bridge loans typically have much higher interest rates than traditional loans. They can be very risky if you don’t plan carefully or have the ability to repay the loan quickly, considering their high interest rates and short loan period.
Bridge loans can be useful financial tools for those looking to purchase real estate but they require careful consideration and planning to ensure they align with the borrower's financial goals and capabilities. So before taking out a Bridge loan, consider these 4 things:
Costs and Repayment
Bridge loans come with higher interest rates and fees compared to traditional loans due to their short-term nature, and increased risk for lenders. Carefully assess the impact of these costs on your budget before taking out a bridge loan.
Ask yourself: Can you comfortably afford the monthly payments on both the bridge loan and potentially your existing mortgage?
Exit Strategy
Ensure you have a clear plan for repaying the bridge loan within the short timeframe. Take time to prepare a plan that works best for you. This typically involves selling your existing property (for real estate) or securing long-term financing within the loan term. Always consider the potential delays and have a backup plan in case of unexpected bumps in your exit strategy.
Equity in Collateral
Bridge loans are often secured by collateral, like the property being financed. Having sufficient equity in the collateral is also crucial. Lenders typically require at least 20% equity, meaning the loan amount cannot exceed 80% of the property's appraised value. Lower equity might lead to the loan being rejected.
Selling Timeline
Bridge loans are ideal for short timelines. Be realistic about how long it will take to sell your current property or achieve your loan payoff goal. Being too optimistic about your timeline can lead to trouble if you're stuck making payments on both the bridge loan and a new property. Consider factors like current market conditions and the unique features of your property.
A thorough plan to ensure a bridge loan is right fit for your project will ensure a smoother transition between financing arrangements and minimize the risk of financial strain or unforeseen challenges.
RCN Capital
Do you have a real estate project you would like to obtain financing for? RCN Capital lends to real estate professionals, commercial contractors, developers & small business owners across the nation. We provide short-term fix & flip financing, long-term rental financing, and new construction financing for real estate investors. If you are looking to finance an investment with a bridge loan, RCN Capital has competitive loan options available.
