A bridge loan is a gap financing arrangement that a borrower can use while waiting for longer-term financing. It is typically taken out for a period of up to 12 months, and used in both residential and commercial real estate. Also, it’s usually more expensive than other types of financing and backed by the cross-collateralization of an asset (e.g. debentures, inventory, properties, or equity).
How Does It Work?
In the real estate industry, bridge loans are quite rare though they do exist. If you’re planning to buy a property with the proceeds from the sale of another, you might want to turn to a bridge loan for your purchase to push through.
While most lenders don’t have stringent guidelines, they tend to favor those with low debt-to-income ratios and excellent credit ratings. Bridge loans add up the mortgages of the two properties so the buyer has more flexibility while waiting for the old house to get sold. But then, lenders normally offer only 80% of the combined value. This means the borrower should have ample liquid assets or significant home equity too.
Most bridge loans have varying structures. Some are arranged as second loans to top off existing liens while others are used to pay off all of the current dues. With the former, a borrower can continue to make payments on both mortgages using the funds from the loan. With the latter, once the original property is sold, the proceeds go towards the bridge loan first.