What is a Bridge Loan? How It Works, Its Types, Requirements, Process, and More

Picture this: you have finalized the new home and are all set to buy it, but at the last moment, the old house faces some delays in the sale. Then what will be the asset to buy your new home? A bridge loan will be the helping hand.

A bridge loan is a short-term cash management financing option designed to “bridge” the gap between the purchase of a new property and the sale of an existing one. Without any further ado, let’s move straight to understanding the bridge loan definition, how do bridge loans work, and more.

Key Terms You Must Know Before Starting:

• Bridge Lending/Bridge Financing: The process of lending or financing bridge loans by banks to borrowers, commonly used in real estate and commercial property transactions, where structured accounting services help manage financial clarity.

• Loan Term: Refers to the duration of the loan for which a loan is offered. 

• Equity: The difference between your property’s market value and the outstanding mortgage balance, often tracked accurately through bookkeeping services.

• Exit Strategy: A planned method to repay the loan, usually by selling a property and settling obligations reflected in year-end accounts & CT returns services.

• Interest-Only Payment: The interest payment of a loan, not the principal amount. 
• Loan-to-Value: The percentage of the property’s value a lender is willing to finance, a ratio commonly reviewed alongside management accounts services for financial planning.

What is a Bridge Loan?

A bridge loan is a type of loan that lenders grant to borrowers for purchasing a new home before selling the existing one. It not only finances the needs of the borrower but also bridges the time gap between buying a new house and selling the old one. 

Highlighting Points About a Bridge Loan: 

• Swing loan and gap financing are other names for a bridge loan. 

• The repayment duration for most of the bridge loans is around 3-6 months, but this can also extend up to 18-24 months, depending on the lender. 

• The current home should hold atleast 20% equity for the approval of a bridge loan. 
• A strong credit profile is essential, similar to eligibility standards used in tax return services.

If you are interested in bridge loans, you must not mistake them for traditional loans, as:

• Bridge loans have a shorter repayment period
• Has a higher interest rate
• Core focused on property equity rather than long-term income stability
• Are easier and faster to access

But that’s not all about the bridge loans. Its existence is for a purpose, and hence it is widely used in real estate. So, let’s find out how does a bridge loan work. 

How Does a Bridge Loan Work?

A lender grants a bridge loan to a borrower by using the borrower’s existing property as collateral while a new property is purchased. The loan amount for the new property is qualified based on the equity proportion of the old property. 

Once the current house is sold, repayment typically occurs within 6 to 12 months, a timeline that often impacts cash flow planning supported by accounts receivable services outsourcing.

What are the Different Types of Bridge Loans?

The bridge loan is mainly classified into 2 categories based on repayment term and lien position

• Closed-Bridging Loan: The repayment date and source are fixed and predetermined to reduce the risk for the lender. 

• Open-Bridging Loan: The repayment date and source are not fixed, offering flexibility to the borrower but increasing the repayment risk for the lender. 

• First Charge Bridging Loan: This loan gives the first claim on repayment to the lender, the first repayment priority is given to the lender of the first charge bridge loan rather than the lenders of some other mortgage. 

• Second Charge Bridging Loan: This loan sits behind some existing mortgage, which makes the repayment of this loan a second priority. It increases the risk for the lender. This hierarchy is similar to prioritization seen in accounts payable services.

What are the Requirements of a Bridge Loan?

To apply for a bridge loan, you must meet the requirements, like a good credit score, low DTI ratio, nominal home equity, and more than 80% LTV ratio. 

• Credit Score: No lender prefers to lend their money to a party who has a bad debt history. Therefore, a 700+ credit score is a must for applying and qualifying for a bridge loan maintained via payroll services.
• Debt-To-Income (DTI) Ratio: Make sure your DTI is low to get easy accessibility to a bridge loan, generally less than 40%. This ratio showcases the ability to manage new debt.

• Home Equity: Atleast 20% equity is a must in the current home to qualify for a bridge loan. 

• Loan-to-Value (LTV) Ratio: The loan amount should not be more than 80% of the property amount. Accurate documentation mirrors compliance standards used in VAT return services.

Documents required: 

• Application form
• Proof of income, like salary slips and bank statements
• ID and address proof
• Bank statements of past few months
• Property documents of the new and current house
• The sale agreement of the current property

How to Get a Bridge Loan? Process Explained

Here is the complete process to follow to get a bridge loan: 

• Find Your Need: The first step is assessing your money needs for bridging the gap between selling the current property and purchasing the new one. Make sure you have 20% equity in the current property to get the greatest financing of up to 80% of the value. 

• Pass the Eligibility: A credit score of more than 700, a DTI ratio of less than 40%, and a stable income are required to qualify for the application. 

• Search for a Lender: Now, reach out to banks or mortgage brokers that offer bridge loans to customers. 

• Apply and Get Pre-Approval: Submit the application along with the necessary documents, like proof of income, ID and address proof, bank statements of the past few months, property documents of the new and current house, and the sale agreement of the current property. 

• Final Approval and Signing: Once the current home is sold, sign loan agreements, pay fees, and receive funds.

Pros and Cons of Using a Bridge Loan

Looking into the pros and cons of the bridge loans can also help you make a choice of preferring them or not. Hence, we have provided pros and cons in a comparison table. 

When to Choose a Bridge Loan?

Bridge loans can be a great choice of financing for you if they fulfill the conditions mentioned below. 

• You are making a time-sensitive purchase of a new property, for which financing from selling your current property is nearly impossible. 

• If you don’t want to avoid moving twice for the new home, once to temporary housing and then to the new house. 

• Without the equity in your present house, you are unable to make a sizable down payment.

• If you have made up your mind to purchase a new house and sell the current house in a short time span. 

• Businesses can obtain a commercial property right away with a bridge loan, which they can later refinance with a long-term commercial mortgage.

Bridge Loan vs. Other Financing Options: What to Choose?

There are mainly three financing options that can be considered as an option instead of a bridge loan, namely Home Equity Line of Credit (HELOC), Home Equity Loan, and Traditional Mortgage. 

• Home Equity Line of Credit (HELOC): It is an ongoing credit line, like a credit card and payroll card, that allows its customers to borrow money against the equity of their home. The credit limit is preset, and exceeding that is not possible without paying down your balance. 

• Home Equity Loan: It allows homeowners to borrow a lump sum amount of money using the equity in their home as collateral. Borrowers can immediately start repaying the amount after receiving the funds. 

• Traditional Mortgage: It is a loan that is borrowed from a private lender, not backed by the US government. Therefore, it requires a good credit score and a 10%-20% down payment. 

Basis	Bridge Loan	HELOC	Home Equity Loan	Traditional Mortgage
Purpose	Funding the gap between buying and selling properties	Gives continuous financial access	To borrow a lump sum amount for purchasing a house	Financing a home for the long term
Duration	Short-term, usually 6-12 months	Long-term, usually 10-20 years	Long-term, usually 5-30 years	Long-term, usually 15-30 years
Approval Speed	Very fast	Moderate	Slow	Very slow
Interest Rate	Highest	Lower than bridge loan	Lower than bridge loan	Lowest
Risk Level	Highest	Lower than bridge loan	Lower than bridge loan	Lowest
Suitable for	Buying a new home before selling the old one	Flexible borrowing over time	One-time large expense	Permanent home purchase

End of the Bridge

In the midst of emergencies, Bridge loans act as a savior. It provides quick and easy access to the short term financing, ensuring the acquisition of good-value property deals or smooth business transitions. 

But as the coin has two sides, it also comes with the drawbacks that may disturb your long-term financing goals. With fast processing, you might get higher interest rates, additional fees, or paperwork as a penalty.