Bridge loans and home equity lines of credit (HELOCs) are two methods of short-term financing used in the real estate industry. They are usually used in the consumer mortgage market to facilitate buying property, but they are also used in the commercial real estate market. Bridge loans and HELOCs are quite different financial instruments, but can be used to accomplish the same purpose, which is buying and selling property. Deciding to use a bridge loan or a HELOC involves analyzing the terms of each and making a choice most financially beneficial to you. Knowing the differences can help you make the best decision for you and your family.
Consider working with a financial advisor when you seek short-term financing for a real estate property.
How a Bridge Loan Works
Bridge loans are used in consumer finance when you want to sell your home and buy another simultaneously. If your current home is for sale and you find another home you want to buy, a bridge loan can serve as short-term financing until your current home is sold or until the mortgage on the new home comes through. It serves as interim financing for your new home.
Bridge loans typically have a term of one year or less with a higher interest rate than many other financial instruments. If you still have a mortgage on your current home and are waiting for it to sell, a bridge loan can provide the down payment. You pay back the bridge loan with the proceeds you receive from the sale of your current home.
The interest rate on a bridge loan is, comparatively, high. Rates may be 2% to 3% higher than a 30-year fixed-rate mortgage and there may even be another percentage or two added to cover fees and administrative expenses. It also usually requires collateral as security. Both the higher interest rates and the necessity of using collateral are because bridge loans can be risky if the homeowner still has to make a mortgage payment on their current home plus a second payment on the bridge loan. Sometimes, terms can be negotiated with the lending institution to require payment at the end of the term for the bridge loan instead of monthly. The bridge loan and all accumulated interest are due and payable when your current home is sold and may even have to be extended.
Most lenders only offer bridge loans that are 80% of the value of the two loans together. You must have enough equity in your old home to be able to qualify. Lenders also look for low debt-to-income ratios when qualifying applicants for a bridge loan.
What Is a Home Equity Line of Credit (HELOC)?
A HELOC is a financial product that allows you to tap into the equity of your home. While a home equity loan is dispersed to you as a lump sum, a HELOC is a line of credit established for you by the lending institution. You can draw out as much as your approved credit line, pay it off and draw it out again. The collateral for your HELOC is the equity interest in your home.
HELOCs have very competitive interest rates, are usually adjustable rate loans and typically have no closing costs. You can use a HELOC in the same way you use a bridge loan if you are trying to purchase a new home. HELOCs are usually granted to only creditworthy borrowers. You usually have to have 20% equity in your current home to qualify for a HELOC.
Just like a bridge loan, you can use the proceeds from a HELOC to make the down payment on a new home, along with the payments on your current home, while you wait for your current home to sell.
Differences Between a Bridge Loan and a HELOC
HELOCs and bridge loans are two financial tools that can be used to accomplish very similar goals, if used correctly. However, like any area in finance, they each come with distinct advantages and disadvantages.
For starters, HELOCs are cheaper than bridge loans. A bridge loan is considered a high-risk source of short-term financing with a payment you pay along with your current mortgage payment. Because of this risk, bridge loans generally have higher interest rates, plus other fees.
In addition, using a HELOC may mean you can enjoy some tax deductibility of the interest payments you make on it. However, that’s only if you itemize your deductions. This is not true for a bridge loan, which, again, gives an edge to HELOCs.
You don’t have to repay the amount you draw down from a HELOC during the draw period. You can wait up to 10 years until the repayment period. During that time, you can take draws on the HELOC up to your credit limit. A bridge loan is disbursed as one lump sum, which could be very important if you need a large influx of cash. On the flip side, you’ll then need to make payments on it immediately.
HELOCs don’t put the same burden on a homeowner trying to buy a new home because the repayment period may start as late as 10 years down the road. During the draw period, you only make interest payments on the loan.
Whether you choose to use a HELOC or a bridge loan as short-term financing in a real estate transaction depends on your situation and your qualifications for each. It also depends on the terms of each type of financing. You may want to work with a financial advisor to help determine which is the best loan for you.
Tips on Home Buying
- Consider working with a financial advisor as you make decisions about handling real estate debt. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you’re looking to get educated about the state of mortgage rate environment, consider using SmartAsset’s mortgage rates table.
- SmartAsset’s mortgage calculator will help you determine how much house you can afford based on your individual circumstances.
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