Although personal loans and credit cards have benefits, they’re not right for every situation. For example, it doesn’t make sense to use a credit card with a 29.99% APR to cover inventory costs for your business. Bridging loans offer a convenient alternative, making them ideal for small-business owners and homebuyers. Learn more about this type of loan to determine if it’s right for you.
What Is a Bridging Loan?
Bridging loans, sometimes referred to as bridge loans, are known as short-term loans designed to give borrowers quick access to cash. You may hear bridge loans referred to as swing loans, gap financing or interim financing.
Bridge Loans for Buying a Home
One of the most common reasons to get a bridge loan is because you want to purchase a new house before someone buys your old house. Most people can’t afford to spend hundreds of thousands of dollars on one house while paying the mortgage on another property.
If you can’t secure funding, you’ll have to wait until your current home sells before you buy something new. This makes it more difficult to find the home of your dreams, as you won’t be able to submit any offers until you sell your existing home. If you qualify for a bridge loan, you’ll get the cash you need right away.
Bridge Loans for Covering Business Expenses
Bridge Loans are also helpful for covering business expenses while you wait for funds to arrive. For example, if you’re waiting for an influx of cash from an investor, you may be able to take out a bridge loan to cover your payroll or buy inventory. Taking out a bridge loan gives you enough time to complete your funding deal without missing payment deadlines and racking up late charges.
Advantages of Bridging Loans
The biggest advantage of bridging loans is that they give you quick access to cash. If you’re buying a home, taking out a bridge loan can help you avoid missing out on the property of your dreams. Once you secure the funds, you can place an offer as soon as you see a listing you like. For business owners, bridge loans make it possible to maintain operations when you don’t have much cash on hand.
Another advantage of bridge loans is that they have lower interest rates than both credit cards and payday loans. In August 2024, the average credit card interest rate soared to 21.76% in the United States, a marked increase from the 16.27% average in 2022. A standard payday loan has an average APR of nearly 400%, making payday loans one of the most expensive forms of borrowing.
In contrast, bridge loans usually have rates one to two percentage points above the prime rate, which is the APR offered to a bank’s most qualified customers. Financial institutions set their prime rates based on the federal funds rate determined by the Federal Reserve. In September 2024, the average prime rate was 8%, which is much lower than the average rate on credit cards and payday loans. As a result, taking out a bridge loan may help you save money.
Disadvantages of Bridging Loans
One of the biggest disadvantages of bridging loans is that they have short terms, usually 6 to 18 months. With a personal loan or a mortgage, you have much more time to repay your principal balance. If you take out a bridge loan, you may have a high monthly payment, leaving you with less wiggle room in your budget.
Many lenders also charge variable rates instead of fixed rates on their bridge loans. A fixed-rate never changes, so your payment stays the same every month. Variable rates change based on market conditions. You may start out paying 8% and have to pay 9% a few months later, causing your monthly payment to increase. If you have cash-flow problems, keeping up with these rate changes may be difficult.
Finally, there’s no guarantee that your home will sell or your business investment will come through before your loan term ends. If you don’t get the amount of cash you expected when you expected it, you may find yourself in a financial crunch.
How to Secure a Bridge Loan
To secure a bridge loan, you must fill out an application and satisfy the bank’s qualification requirements. For example, you’ll need a low debt-to-income ratio (DTI) and a good credit score. Your DTI compares your monthly debt payments to your gross monthly income. Here’s how to calculate your ratio:
- Add up all of your gross monthly income. For this example, assume you have $5,000 in gross income per month.
- Add up your monthly debt payments. In this scenario, assume you have a personal loan and two credit cards. Your monthly payments are $427, $40 and $25. This adds up to $492.
- Divide your gross monthly income ($5,000) by your total monthly debt payments ($492). Multiply the result by 100. In this example, your DTI is 9.84%.
The lower your DTI, the easier it is to work loan payments into your monthly budget.
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