Capital Max | Understanding Why Bridge Loan Debt on Riskier Assets is More Expensive

Capital Max

Bridge Loan

A bridge loan, also known as a hard money loan or interim financing, is short-term financing used by a person or business to meet current obligations until a permanent loan is secured. 

These loans are generally secured by collateral, such as the borrower’s assets or home. This makes them a perfect loan choice for homeowners facing sudden transitions, such as having to relocate for work. They can use the bridge loans to purchase their new home while using their previous home as collateral.

However, these loans have a high interest rate of 8.5%- 10%, making them costlier than other traditional, long-term financing options.

Types of Bridge Loans

It’s crucial to understand the types of bridge loans, as this knowledge will empower you to choose the most suitable option for your needs. The four main types are close-bridging loans, open-bridging loans, first-charge bridging loans, and second-charge bridging loans.

Close Bridging Loan

A close-bridging loan is available for a predetermined time frame mutually agreed upon by both parties. Lenders are more likely to accept this loan because it gives them certainty about loan repayment. It also attracts lower interest rates than an open-bridging one.

Open-bridging Loan

Also known as a no end debt bridging loan, the time of the bridge loan debt repayment is open and not determined at the time of initial inquiry. The time frame isn’t fixed, and to ensure the security of their funds, many bridging lenders deduct the loan interest from the advance. 

This type of bridge loan is preferred mainly by borrowers uncertain about when their finances will be available. Due to this uncertainty, lenders charge a higher bridging loan interest.

First charge bridging loan

A first-charge bridging loan gives the lender a first charge over the collateral property. If there is a default in payment, the bridge money lender will receive its money first before other lenders.

Second-charge bridging loan

For a second-charge bridging loan, the lender takes the second charge after the current first-charge lender. While the second lender has the same repossession rights as the first-charge lender, it only starts to recoup payment from the client after the first-charge lender has been paid. The loans from second-charge bridging loans are usually for a short period and carry a higher interest rate.

How Do Bridge Loans Work?

A bridge loan can be used to make a down payment for a new home in the real estate industry. Often, when a homeowner wants to sell their current home and purchase a new one, it can be challenging to sell the old home and get the funds for the new one within the same time frame. 

That’s where bridging loans come in. A homeowner can work with a lender to obtain a short-term loan that can help “bridge the gap” between their new purchase and the sale of their old home.

Once the borrower’s old home is sold, they can use the proceeds to pay off the loan and will be left with the yearly mortgage on their new home. However, if the borrower’s old home doesn’t sell within the period of the loan term, they’ll be responsible for paying for the mortgage of their new home as well as the bridge loan. This makes a bridge loan a risky decision for homeowners who aren’t sure their homes are likely to sell within that loan time frame.

Businesses can also use bridge loans when awaiting long-term funding and need financial assistance to cover operational expenses in the interim. For example, a company doing a round of equity financing that is supposed to last six months or less may opt for a bridge loan to cover its inventory costs, payroll, and utility bills until the round of funding goes through.

Pros of Bridge Loans 

Immediate Financing

One of the perks of bridge loans is that they provide immediate financing, allowing you to seize opportunities that you might otherwise miss due to a lack of funds. With a bridge loan, you can make time-sensitive transactions as some lenders can fund in as quickly as two weeks, providing a sense of relief in urgent financial situations.

Less Paperwork 

Qualifying and getting approved for a bridging loan takes less time and paperwork than a traditional loan. This quick processing of the loan gives you the convenience of buying your new home while waiting to sell the old one. The long waiting times for traditional loans might force you to rent an apartment, which might affect your budget.

Payment Flexibility 

Bridge loans offer a high degree of flexibility in payment plans. You can start paying the loans while you wait for the sale of your old house or choose to make interest-only payments. This flexibility empowers you to manage your finances according to your current situation.

Cons of Bridge Loans

Equity requirements

Many lenders require at least 20% equity in the current home, which might be a barrier to entry for some.

Higher Rates

These loans are costly because they are short-term bridge financing. This can be due to high interest rates and related fees like front-end charges, valuation payments, and lender legal fees.

No Borrower Protection

Many bridge loans don’t come with security for the borrower if the sale of the old home falls through. At times, the lender can go as far as foreclosing the old or current home, leaving you with no home and more financial distress than you started.

Bridge Loan Costs

While bridge loans can be a convenient way to obtain short-term financing, they are usually more expensive than traditional loans. Bridge loan interests can range from 8.5% to 10.5%, and for businesses, they can range as high as 15% to 24%.

Additionally, the borrower must pay closing costs and legal and administrative fees. Closing costs for a bridge loan range from 1.5% to 3% of the loan amount and may include a notary fee, appraisal fee, escrow fee, and loan organization fee.

Bridge Loan Alternatives 

Here are some alternatives to bridge loans that don’t charge high interest and don’t put you at risk of losing your home.

Home Equity Line of Credit (HELOC)

This loan alternative allows homeowners to take out a line of credit against the value of their own homes. Loan holders can draw against a Home Equity Line of Credit on a revolving basis, and these lines have repayment plans for up to 20 years. This means borrowers have a longer time to pay their debt. They are also less likely to default and lose their homes. 

Also, interest rates on the Home Equity Line of Credit are refinanced at a lower interest rate, like 2%— as opposed to the 10.5%, which may be slammed on bridge loans. Instead of securing a short-term bridge loan to cover a down payment, homeowners can take a HELOC, draw against it, and pay it off once they sell their old home.

Home Equity Loan

Like the Home Equity Line of Credit, a home equity loan allows borrowers to draw against their home equity. In contrast to the Home Equity Line of Credit, where borrowers can draw against the lines as needed, this loan is a lump sum payment. This loan is suitable for homeowners who know how much they will need to cover the downpayment of their home. The typical interest rate for this loan is also about 2%.  

80-10-10 Loan

This loan helps homeowners get a mortgage covering 80% of their home purchase price and use that to get a second loan for 10%. That means the homebuyer has to provide 10%  of the purchase price as a down payment — hence the name, ” 80-10-10 loan.”

Business Line of Credit

This is a loan that businesses can access to cover short-term expenses. Similar to the Home Equity Line of Credit, organizations, and businesses have to draw against the line as needed. Loan repayment terms can range from a few months to 7 years, and the interest rate can be as low as 7%.

Bridge The Gap With A Bridging Loan At Capital Max

If you are ready to take the next step and apply for a bridging loan, our team at Capital Max is here to help. We know the loan process can be complex and overwhelming, but we’re committed to making it easy. Whether you have questions about the application process, required documents, or loan terms, we’re here to provide clear and honest guidance. Contact us today to get started on your loan application, and let us help you take your business to the next level.