A bridging loan is a loan that is requested due to an immediate need for financing and that is temporary, until the final loan is formalized, provided that a future income is ensured by the borrower or debtor.
In a bridge loan we find three main characteristics:
- Immediate need for financing, as we will see in the next section.
- Temporary nature. This means that the bridge loan is temporary, until the final loan is formalized.
- There must be a guarantee of future income by the borrower, which ensures the repayment of the credit. Without this guarantee, the financial institution will not grant the credit.
When is a bridge loan granted?
The main purpose of the bridge loan is the acquisition of a new home without the need to quickly sell the current home. That is, the bridge loan allows the borrower various options:
- Acquire a new home that may not yet be built and requires some type of advance payment (immediate need for financing)
- Have a reasonable time to sell the current home, and not be forced to sell it quickly.
Bridging loans can have other purposes such as, for example, obtaining immediate financing while the final loan is formalized (which usually takes a few days) or for business purposes. However, in this analysis we are going to focus on its main purpose.
Bridge loan operation for the acquisition of a new home
With the bridge loan, the financial institution usually integrates the current home loan and the bridge loan into one. However, on the bridge loan, only interest is paid, while on the previous loan, interest and principal are paid.
Usually a maximum term (or grace period) is established for the borrower to sell his current home. Once that happens, the credit associated with that home disappears with the sale and the bridge loan as well. Then the definitive mortgage loan is formalized.
What happens if the current home is not sold
It may happen that, once the grace period ends, the current home has not been sold. In this case, the borrower must return the entire amount granted by the financial institution, in addition to the interest. That is, after the end of the grace period, the borrower must pay the principal and interest, both on the bridge loan and on the current home loan.
Advantages and disadvantages of the bridge loan
The main advantage of the bridge loan for the borrower is that it allows him to sell his current home with peace of mind, without the need to “sell it”. In addition, during the grace period, although it de facto has two credits, it is only repaying one, since the bridge loan only pays interest.
However, this credit also has several drawbacks. The main one is that, if the current home is not sold, the bridge loan must be returned, including interest, in addition to the first loan. On the other hand, the bridge loan is a risky operation for financial institutions, so the interest rate of these loans is usually higher and the requirements for their granting are also higher than in others (a higher solvency must be accredited) .
Bridging loans have their meaning in times of economic growth, in a context in which the sale of homes is relatively simple. On the other hand, in times of economic crisis derived from a real estate crisis, these loans lose their reason for being due to the difficulty of selling homes at a reasonable price.