Take a Rational Attitude Towards Bridge Loans

A bridge loan is a short-term loan in nature, with very short repaying terms and extremely high interest rates.  The term “bridge” indicates that this kind of short-term loan can fill the gap where you feel strapped of cash.

When need a bridge loan?

Let’s suppose you need to move to some place permanently from your present residence. After shopping around carefully in the new place, you finally find a nice property on sale in a very low price, because the homeowner has to sell the house as soon as possible. You check out the property again and decide to buy it.

Now comes the problem. You don’t have sufficient funds in hand to purchase the new house, or even to pay for the down payment. But you really want that house, and it is the right time to buy it in a low price. Opportunity seldom knocks twice!

In this case, selling your existing home seems to be the only way.

Here are two scenarios:

  •  Scenario one: Your existing house can be sold right away. You can use the sales of the house to pay off your existing mortgage(s) in order to transfer a clear title to the buyer. Then the remaining proceeds can be used to put the down payment of the new house. If that is the case, you don’t need a bridge loan at all. But what are the odds?
  •  Scenario two: it’s hard to sell your old home in a short time. Thus, you can’t tap your home equity to purchase the new one. Under this circumstance, you need a bridge loan to purchase the new house before your sell your old one successfully.

What are the merits?

The most appealing thing of a bridge loan is that you can get the cash immediately after you apply for it, especially when you are at pinch. Once you take out a bridge loan successfully, you can use the money to purchase the new house before the deal is closed. And when your house is sold, you pay off your bridge loan with the sales of the old home.

The bridge loan seems a win-win solution to your financial dilemma, unless you default on the loan.

Are there any risks?

Yes, of course. First of all, the extremely high interest rate can get you blocked in another round of financial hardship. The interest rate is determined by your bridge loan types.

There are two types:

• Closed bridge loans

When you take out a closed bridge loan, you are required to pay off the loan before an exact date. In other words, the lender can undoubtedly get back the principal as well as the interest on that day.  So for the lender’s part, the risk is relatively low. And for that reason, you can enjoy a relatively low interest rate.

• Open bridge loans

On contrary, an open bridge loan refers to a loan that the lender is not sure when the borrower will pay back. Therefore, this kind of loan seems more risky than the closed bridge loan. And you will be charged a relatively high interest rate.

Second off, suppose there is a mortgage on your old home, and you have not paid off it yet. Now you get a bridge loan in order to buy a new house. The down payment of new house is paid by using the bridge loan, and hence, you have to make a monthly payment on your new mortgage.

Think about it. Before your old house is sold, you have three loans in your hand. To prevent your old house from default, you have to make payments every month, since your first mortgage is secured against your home, and once you default on the old house, the lender are entitled to foreclose it. Sometimes there is no need to inform of you about it. The bridge loan is the second mortgage on your old house. So you have to pay back this loan as well to keep the title of the house. The third mortgage is secured against your new house. So you should make monthly payment to build up the home equity.

Take a rational attitude towards it

Although taking out a bridge loan may leave you risks and troubles, it is a choice when you really have no other alternatives. And you can get the cash flow fast. So the lender uses this convenience in exchange for high interest rate. Fair enough. If you think you may have trouble in paying off the loan, I suggest you purchase a less expensive house so as to leave more proceeds to pay off the bridge loan when the old house is sold.

However, if you are not at pinch, or you have other financial options, then I have to say that a bridge loan is not your first choice. The most common way is to wait until you settle an agreement on the house price with the buyer and sell your house successfully. When you have received the proceeds after selling the house, you are no longer in need of any loans.

Or you can get a home equity loan instead of the bridge loan. Be noted that lenders of the home equity loan seldom lend you money if your house is on sale. Because your house is the security of the home equity loan, the lender will take more risks if the security is on the market. So if you are not in a hurry, you can make a plan and take out a home equity loan to purchase a new house, and then sell the old one before the regulated period ends. The interest rate of a home equity loan is typically lower than a bridge loan.

In brief, we maintain that it is not fair to say that bridge loans are good for nothing. They are just not the first options when you need to tap into your home equity.