Bridge loans are typically used during the process of purchasing a home to “bridge” the gap between the sales price of your new home and your new mortgage on that residence in the event your existing home doesn’t sell before closing. A HELOC can have many different uses. Using a home as collateral can be risky, as this gives the lender rights to the house if payments are not made. However, if you’re able to make the payments, these loans can help provide needed funds. See how a bridge loan measures up against a HELOC.
What’s the Difference Between Bridge Loans and HELOCs?
Bridge loans and HELOCs are similar in that they both rely on the home’s equity for an approval. Home equity equals the difference between the current market value of your home and how much you still owe on the mortgage. The standards for collateral may be similar for both types of loans, but there are several differences between bridge loans and HELOCs. Deciding whether to use a bridge loan or HELOC depends on your preferences and other considerations, such as specific loan requirements and the overall process for securing each. Bridge loans are typically used to cover closing costs. HELOCs, on the other hand, can be tapped for different reasons, including education expenses, home renovations, starting a business, and to cover other financial needs.
Structure of the Loan
The structure of each of these loans differs greatly when it comes to term length. A bridge loan is considered a short-term loan. It is expected to be paid off much sooner than a HELOC. Generally, borrowers have about a year until they must begin making payments. For a HELOC, borrowers may have several years, depending on the lender’s terms. Payments are required for both products, though the payments might not always include the principal. If you check the reference you have for a bridge loan, you may see “interest-only payments for 12 months.” In that case, it would be the same as a HELOC during the draw period—interest-only payments.
Lump Sum vs. Revolving Credit
A bridge loan provides a lump sum to the borrower, while a HELOC lends the borrower limited funds in a revolving line of credit. HELOC funds are available on an ongoing basis. The lender sets a limit, similar to a credit card, and the borrower can spend up to that amount. In the long run, the borrower can end up borrowing more funds in total from the HELOC, as long as they consistently pay in full at the end of each billing period. However, if the HELOC is used for purchasing a new house while selling the current house, most lenders require borrowers to pay off the HELOC once the previous house is sold because that equity used as collateral is gone.
Interest Rates
The way interest rates are charged differs because of the way each loan is structured. Because bridge loans are disbursed in a lump sum, interest is charged on the full amount provided, even if the borrower doesn’t use it all. On a HELOC, the interest is only charged on the funds borrowed. As a line of credit, the borrower may prefer keeping charges small to reduce interest costs. The levels of interest rates incurred are also different when comparing a bridge loan and a HELOC. In general, bridge loans incur higher interest rates due to their greater element of risk, while interest rates for HELOCs are typically lower.
Which Is Right for You?
Deciding whether to move forward with a bridge loan or a HELOC depends on your personal preferences and your ability to repay the loan. Usually, if you’re looking for a larger sum of money to put toward your new home, you’ll want to consider a bridge loan. On the other hand, if you don’t think you’ll be able to promptly repay the loan, you may opt for a HELOC, as it provides longer terms for repayment. Make sure to conduct your research, because different lenders will provide a variety of options and terms. You may also want to calculate other incurred costs down the line. For example, if you’re looking to put a 20% down payment on the home, the bridge loan can help provide this sum of money. In the long term, putting up this amount reduces the monthly mortgage payments because private mortgage insurance (PMI) will not be required. On the other hand, if you have some money saved for your down payment but you’re looking to combine some additional funds, you may benefit from a HELOC instead. A smaller loan, combined with your savings, can help reach that 20% down payment.
The Bottom Line
A bridge loan and a HELOC each can serve as an option when you’re looking to buy a house. While there are pros and cons to each loan, you’ll need to consider what works best for your personal finances. Keep in mind that using your home as collateral is risky, as it allows the lender to foreclose on the house if loan payments are not made. If you’re in a competitive housing market and want to have an edge with lenders, you can opt for a bridge loan to obtain a lump sum to make a minimum 20% down payment. On the other hand, you may opt for a HELOC if the market isn’t so competitive, or you want the flexibility to use the funds for other purposes. Make sure to conduct your research and compare lenders to find the best options.
