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How Do Bridge Loans Work?

A photo of Bridge Contract form

A bridge loan is a short-term loan that allows a buyer to purchase real estate while waiting for their application for permanent financing to be approved. This loan of up to one year comes with a relatively high-interest rate. Lenders require some sort of collateral – typically real estate. Knowing what a bridge loan can do for you is essential if you’re considering going this route.

How bridge loans work

Bridge loans are also known as gap financing, swing loans, or interim financing. They help when you need funding, but it is not yet available. Both individuals and corporations can apply for a bridge loan, which can be customized depending on the situation.

Bridge loans allow you to buy a new property while you’re waiting for your present one to sell. As a borrower, you can use the equity in your current home as down payment for the purchase of a new home.

Expect to take on a higher interest rate with a bridge loan than you would with other credit options, such as home equity line of credit (HELOC). You will need to make two payments: one to pay for the bridge loan and another for your current mortgage until the home’s been sold. Take note, too, that lenders will only offer a bridge loan equivalent to 80% of the combined value of both properties.

The pros

  1. Bridge loans offer structural flexibility. You can decide how much of the credit they would like to use to pay off existing liens and how much of it to use as down payment for the new property you’re eyeing. 
  2. As a borrower, you won’t be required to start paying back the bridge loan right away. There’s a grace period before the first payment is due, which can provide you enough breathing room to first get your finances in order.
  3. Bridge loans also make it unnecessary for you to draw up a contingency contract. The loan will enable you to fulfill your contractual obligations on time, making it redundant for the seller to issue you a notice to perform.

The cons

  1. If your property is financed using a bridge loan, expect lenders to inflate closing costs on the assumption that you are highly motivated to purchase the property.
  2. A bridge loan’s interest rate is typically two percent higher than the usual mortgage loan. The lender, however, also has an option to increase your interest rate depending on the perceived level of risk.
  3. Your property, as collateral, may be used to pay off the bridge loan if things don’t go as you had hoped. Your current home may not have sold as anticipated or your financing could have fallen through, in which case the lender could opt to initiate foreclosure proceedings. 

If you’re still unsure if bridge loans are for you, consult a reputable real estate professional like Certified Residential Specialist Cheryl Heyermann, who leads The Peninsula Group Real Estate. With over 30 years of real estate experience on the Monterey Peninsula, we have listings for homes for sale in Pebble Beach, CA, at the best prices in the market. We specialize in Pebble Beach luxury real estate, and we’d love to hear from you. Get in touch with this expert team at 831.595.5045 or email info(at)ThePeninsulaGroup(dotted)com.