5 Bridge Loans Dangers and Pitfalls

Bridge loans can be effective tools for buying a home either as your primary residence or as an investment. They are particularly useful if you have good credit but little cash on hand and expect to have cash soon, typically from the sale of another house. At the same time, there are pitfalls when financing with bridge loans. It is important to understand what these loans are and the dangers they can pose. 

Understanding a Bridge Loan

Bridge loans are short-term financing, usually 12 to 36 months, that allow you to buy an asset now, pay back the bridge loan with the sale of another asset and then get a traditional mortgage on the new property you acquired. Bridge loans are easier to qualify for, faster to get approval for and often can be converted to a longer-term mortgage by the same lender.

Bridge Loans Have Higher Interest Rates

A big drawback of bridge loans is the interest rate.  It is usually at 2 percent above standard mortgage rates. All lending is based on the risk assumed by the lender. In most cases, the borrower’s financial condition won’t meet the requirements for a traditional mortgage until a home is sold. Lenders have more latitude to make a judgement call when offering a bridge loan than with a 30-year mortgage, but because the risk is higher, the interest rate will be higher. Be certain that if you are counting on the sale of home to pay off the bridge loan, that the added cost of financing doesn’t make your new home purchase a bad deal.

Bridge Loans Means Double Fees, Payments

In addition to paying higher interest rates, bridge loans have many of the same fees a long-term mortgage does, some of which you will have to pay again when you pay off the bridge loan and convert to a traditional mortgage. Additionally, for the period you have the bridge loan, you will be paying monthly on that loan and your current home loan.

Your Home Equity Can Be at Risk

Most bridge loans will not cover 100 percent of the new home to be purchased, 80 percent is the mortgage industry standard.  The borrower often uses equity in a current home as collateral for the loan. If the first home does not sell, and you cannot pay off the bridge loan for the new home, you could face foreclosure on the loan on your existing home. It is important to gauge the likelihood of selling your home.

More Work for You

Bridge loans are a far smaller piece of the lending industry than mortgage loans. You can compare mortgage loans online easily and narrow your options. But bridge loans are unique to every borrower and lender. You will have to put in the time to talk to local bankers and find the best terms, fees and rates for you.

Need Cash Now? Get a Cash Advance