In answering the questions, "how does a bridge loan work," we will set forth our definition of a real estate bridge loan and propose a series of hypothetical situations where a real estate bridge loan is useful.
A real estate bridge loan is a short-term loan that is used for meeting urgent financial needs. The term of such a loan is up to one year and just like a long-term loan it is backed by real property (the collateral).
A real estate bridge loan is obtained as a temporary measure until either permanent financing is secured or the collateral is sold. A real estate bridge loan at a higher interest rate is also known as a hard money loan. You would seek a real estate bridge loan in one of the following scenarios:
1. You are in contract to buy a property and are pressured to close soon. You are still waiting to sell a property you own – the sale's proceeds of which you rented to use for the purchase. You do not want to go through the hassle of permanent financing on the property you own just for a few months; a permanent loan takes a while to close and it is likely to include a hefty prepayment penalty. A real estate bridge loan allows you to purchase the property you want while giving you the time to sell the property you own. (This situation can arise in a 1031 Exchange).
2. Your bank has just backed out of a loan commitment to you. You are expected to close next week and the seller already has another buyer in case you can not close. There is not enough time to go to another bank, and you could lose your earnest money. A real estate bridge loan enables you to close.
3. You are buying a property for conversion. No bank is willing to lend to you on this project. You need bridge financing to carry you through the purchase and the construction. A real estate bridge loan is the perfect solution.
4. You are buying a run-down property to redevelop. No bank is willing to lend to you on this property. Here, too, you need bridge financing for the purchase and renovation. With a real estate bridge loan you can seize the opportunity.
5. Your credit score has just been hit, and no bank is willing to lend to you. You need interim financing. A real estate bridge loan gives you a chance to fix your credit and obtain a permanent loan later.
6. An opportunity has just arisen. You need to move fast, and no bank can provide the capital fast enough. A real estate bridge loan makes your deal happen.
7. Your partner needs quick cash and wants to be bought out. A real estate bridge loan provides you the means.
8. The mortgage on your investment property is maturing with a balloon payment due shortly. You are not prepared to pay it off and risk foreclosure and damage to your credit. A real estate bridge loan preserves your credit and give you the needed time to sell or refinance.
In short, a bridge loan can be the perfect solution to your mortgage needs.