A bridge loan is a fairly straightforward concept: when you are engaged in two transactions at once, one as a buyer and the other as a seller, you obtain a loan to cover the purchase which you will then pay off with the proceeds of the sale when it is complete. A bridge loan is most often seen in the context of an individual transacting to purchase a new home at the same time they are trying to sell their old one. The idea is that you buy your new house on a loan, and then pay it off just as soon as your old house sells, thus the loan bridges the temporary gap in your finances to allow you to move faster. It’s a clever enough plan and can definitely work out most of the time. However, as with most things, there are pros and cons to using bridge loans, which we’ll discuss below.
The Pros of a Bridge Loan
Let’s lead with the upside. A bridge loan is a great way to come up with the extra money you need to buy a new house and obviates the need to wait around until your old place sells before you can move into your new abode. This is not just a pro because it appeases the impatient buyer – it may mean the difference between getting your dream house and missing out on it. For example, imagine that you found your dream home, but you don’t quite have the funds to make a sufficient down payment on it. You could wait around to obtain the funds by selling your current home, but your dream house could get snapped up by someone else in the interim. Using a gap loan allows you to make an offer now and guarantee that you get the house.
This is usually a more attractive approach for a seller than a contingent offer – an offer from the buyer saying they’ll buy the home if and when their own house sells. Sellers want the money now and will take your offer more seriously if its non-contingent. Therefore, this might be the way to go as a buyer, but you’ll want to consider it carefully and consult with a local real estate firm for advice before committing.
The Cons of a Bridge Loan
Of course, there has to be a catch to bridge loans. One of the most salient disadvantages of bridge loans is that they typically come with higher interest rates. Bridge loans are meant to be a short-term fix, something a buyer takes out for a very brief period of time and then pays off in full once their own real estate sells. Consequently, lenders jack up the interest rate compared to longer term loans, since they know they won’t have a lot of time in which to collect interest.
A less obvious, but more important, downside is the risk undertaken when using a bridge loan to finance a real estate transaction. What happens if you take out a bridge loan to finance the purchase of a new house until your old one sells, but then your old house sits on the market forever? You’d be the proud borrower on three separate loans: your old house’s mortgage, your new house’s mortgage, and the bridge loan. This can result in a significant monthly expense until your original home does eventually sell.
Categories: Real Estate