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What Is a Bridge Loan and How Does It Work?
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A bridge loan is a short-term loan on your current home’s equity that is used to make a down payment on a new home. A bridge loan comes in handy if you need extra cash to buy a new home before selling your current home and want to make an offer without it being conditional on your home selling first.
Learn how bridge loans work, the costs involved and pros and cons to determine if they’re a good fit for your homebuying situation.
What is a bridge loan?
A bridge loan, also known as a swing loan or gap loan, is a short-term mortgage that lets you borrow equity against your current home, even if it’s for sale, to use toward the down payment on a new home. Your home equity is the difference between your home’s value and the balance of your mortgage.
Unlike standard refinance, bridge loans allow you to borrow against your current home’s equity even if it’s listed for sale. Bridge loans also help with the balancing act of buying and selling a house at the same time.
How does a bridge loan work?
In some ways, a bridge loan works like any other mortgage. The lender qualifies you based on a review of your income, assets and credit and requires an appraisal to confirm your home’s value. However, there are some important differences:
You’ll need to choose whether the loan is a first or second mortgage. You can borrow more than you currently owe and pocket the difference with one mortgage, or you can take out a smaller loan against a portion of your home’s equity with a second loan. Here’s how each works:
- First-mortgage bridge loan. A lender offers you a loan to pay off the balance of your mortgage plus enough for a down payment. Your current mortgage is paid off, and the bridge loan takes first position until you sell your current home, at which point you pay off the loan.
- Second-mortgage bridge loan. A lender offers you a loan in the amount you need for a down payment on your new home. The loan is secured by your current home, which makes it a second mortgage.
You’ll typically be able to borrow up to 75% of your home’s value. Whether you take out a first- or second-mortgage bridge loan, you won’t be able to tap all of your home’s equity. A bridge loan may not make sense if you don’t have more than 20% equity.
You may have options for how you make your monthly payment. Depending on the lender’s terms, you may make interest-only monthly payments, no payments until the home is sold or fixed monthly payments.
You’ll pay closing costs and possibly have a prepayment penalty. Expect to pay 1.5% to 3% of the loan amount in closing costs for a bridge loan. Additionally, bridge loan rates can be as high as 8% to 10%, depending on your loan amount and credit profile. Steer clear of any lender that asks for an upfront deposit for a bridge loan; you’ll pay all bridge loan fees when the mortgage closes. Check your bridge loan terms for a prepayment penalty.
Bridge loan example
Below is an example of the math involved in a bridge loan for the following situation: you buy a home priced at $400,000, your current home is worth $350,000, you owe $150,000 on your current mortgage and the bridge loan company can lend you 80% of your home’s value.
|First-mortgage bridge loan||Second-mortgage bridge loan|
|Current home||$350,000 current value |
X .80 (80% of value)
$280,000 first-mortgage bridge loan
($150,000) current mortgage payoff
$ 130,000 cash back for new purchase
|$350,000 current value |
X .80 (80% of value)
$280,000 maximum both loans
($150,000) current loan balance
$ 130,000 second-mortgage bridge
($130,000) bridge loan down payment
$270,000 needed for new home
($130,000) bridge loan down payment
$270,000 need for new home
Bottom line: In the example above, a bridge loan converts $130,000 of your home’s equity to cash you can use to purchase your new home while you wait for your current home to sell.
Pros and cons of bridge loans
|You can use your current home equity to buy a new home without selling it right away||You’ll pay high interest rates and closing costs|
|You won’t clean out your savings account||You could have up to three monthly mortgage payments for a period of time|
|You can make offers without contingencies for the sale of your current home||You could lose both homes if you can’t make payments and the bridge lender forecloses|
|You may be able to make interest-only payments||You may have a harder time finding a bridge lender|
|You can make a larger down payment on the home you’re buying using your current home’s equity||Your loan may be considered riskier with fewer federal protections|
When you need a bridge loan
A home bridge loan makes the most sense in fast-moving, competitive real estate markets. If sellers aren’t accepting contingencies, you could make a contingency-free offer by using a bridge loan.
Some other scenarios that a bridge loan may help with:
A new home purchase in a hyper-competitive market
When there are multiple bidders for a home, sellers aren’t as likely to accept an offer contingent on the sale of your home. However, if you need the funds from your current home to make your new-home payment affordable, a bridge home may help you get enough cash to bridge the gap until your home sells.
A fix-up home purchase
If you’re buying a property that needs significant repairs, but those repairs don’t meet traditional loan guidelines, a bridge loan may help. For example, Fannie Mae’s HomeStyle® Renovation loan limits renovation funds to either 75% of the purchase price plus renovation costs or 75% of the “as-completed” appraised value.
If those restrictions don’t give enough funds to buy and fix up the home, a bridge loan might give you the extra money needed to complete the renovations without dipping into your savings account.
A fix-and-flip home purchase
A bridge mortgage might also make sense if you’re fixing and flipping a home. Flips are designed to be short-term, and if everything goes according to plan, you can repay the loan when renovations are complete. You may be able to obtain a bridge loan faster than traditional financing, allowing you to snap up a property quickly.
Bridge loan requirements
Lenders will look at a few factors to see if you qualify for a bridge loan:
- Equity. You’ll need at least 20% equity in your current home.
- Affordability. You’ll need enough income to qualify for up to three house payments.
- Housing market. If your home is in a sluggish housing market. You may have to make up to three different mortgage payments for longer than expected, which can strain your budget and drain your savings.
- Good to excellent credit. You must show that you’ve handled debt responsibly in the past, although some bridge loan programs may allow scores as low as 600.
Where to find bridge loan lenders
Bridge loans are a specialized product, and not all lenders offer them. Ask the lender you’re working with for the new home purchase about whether it offers bridge loans. If it doesn’t, consider these options:
- Local banks and credit unions. If you already bank with a local institution, ask about bridge loans. Even if you don’t bank with them, local banks and credit unions offer personal service and understand your local real estate market.
- Non-QM lenders. Non-qualified mortgage (non-QM) lenders specialize in alternative mortgage products like bridge loans. Non-QM loans have features that aren’t allowed in qualified mortgages, like interest-only and balloon payment structures.
- Hard-money lenders. Hard-money lenders are individuals or groups of investors who offer loans with short repayment terms, like bridge loans. They tend to have higher interest rates, but they may not be as stringent when it comes to credit requirements. Confirm the lender is reputable before working with one.
Verify that any loan officer or institution you’re considering is appropriately licensed by visiting the Nationwide Multistate Licensing System Consumer Access website. You can search by loan officer or company name and confirm they’re licensed in your state.
Bridge loan alternatives
Before you take out a bridge loan, consider alternatives such as:
- Home equity line of credit (HELOC). This product is a line of credit that works like a credit card. If approved, you can borrow as much as you need up to your credit line’s limit, and many HELOCs offer the same interest-only bridge loan payment option. Like a bridge loan, this alternative uses your home as collateral.
- Home equity loan. With this alternative, you borrow against a percentage of your home’s equity as a lump sum that you start paying right away. Your current home secures the mortgage.
- Cash-out refinance. To use a cash-out refinance as an alternative to a bridge loan, you would replace your current loan with a larger mortgage and use the difference for a new-home down payment. Keep in mind: The home you’re refinancing can’t be listed for sale when the loan is disbursed.
- 80-10-10 piggyback loan. With this option, instead of taking out a home equity loan or HELOC on your current home, you take out two loans on the new home and make a 10% down payment: one for 80% of your home’s value and the other for 10%. When your current home sells, you can pay off the 10% second, and you’re left with only one mortgage payment (if you make enough profit from your current home sale).