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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 that allows you to use your current home’s equity to make a down payment on a new home. Also called a swing loan or gap financing, a bridge loan can be especially helpful if you’re buying and selling a home at the same time.
Using a bridge loan to buy another home without making that purchase contingent on selling your existing home first might make your offer more appealing to sellers. However, bridge loans also come with higher interest rates than traditional mortgages and several fees, such as origination charges and a home appraisal.
What is a bridge loan?
A bridge loan is a short-term loan (typically 12 months or less) that allows you to borrow against a portion of your current home’s equity to make a down payment on a new home. Your home equity is the value of your home less the balance of your mortgage.
A bridge loan helps with the balancing act of buying one home while selling another. While they can be helpful, these loans have a few drawbacks. In addition to having higher rates and several fees, a bridge loan uses your current home as collateral, which gives the lender the right to foreclose if you don’t repay the loan. And if your home doesn’t sell, you could be on the hook for repaying the bridge loan and your new mortgage, leaving you with two mortgage payments to manage.
How a bridge loan works
A residential bridge loan can either take first position as the primary mortgage on your current home or second position. Here’s how each scenario 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.
With a bridge loan, you can typically borrow up to 80% of your home’s value. Depending on the lender’s terms, you may make interest-only monthly payments, no payments until the home is sold or fixed monthly payments.
Bridge loan lenders also vary when it comes to fees, but you’ll typically have an origination fee at least. You may also have to pay escrow and title fees. Some bridge loans also have a prepayment penalty.
Bridge loan example
Let’s say your current home is worth $175,000. You owe $75,000. You’re looking at buying a new home for $275,000, and you want to make a 20% down payment of $55,000.
With a first mortgage bridge loan, you borrow $135,000. You pay off your mortgage, which leaves you enough to make a 20% down payment and $5,000 left for closing costs.
With a second mortgage bridge loan, you borrow $60,000. You make a down payment on your new home and have $5,000 left for closing costs.
Bridge loan fees
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.
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 home.
- Affordability. Lenders will look at whether you can afford to make multiple loan payments. You may be paying for a bridge loan plus a mortgage on your new home and your current mortgage until the home sells. You’ll need to have enough income to cover the payments or enough cash reserves to pay off the loan if required.
- Housing market. How quickly will your home sell? If your home is in a sluggish housing market, a bridge loan may not be a good fit. Plus, you may wind up making three different mortgage payments for longer than you expect, which can strain your budget.
- Good-to-excellent credit. You need to show that you’ve handled debt responsibly in the past.
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, 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 mortgages 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 they’re 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.
Pros and cons of bridge loans
|Take more time to sell your current home.||Pay relatively high interest rates plus closing costs.|
|Keep your savings intact.||Have a higher risk of foreclosure since your home is serving as collateral.|
|Make offers without a contingency, which makes you more appealing to sellers.||Have to make payments on multiple mortgages.|
|Make interest-only payments until your home sells, in most cases.||May be harder to find a lender as it’s a niche product.|
|Move from your current home to your new home without having to rent or store your belongings.||Have fewer federal protections than with traditional mortgage products.|
|Make a larger down payment than you could otherwise.|
When you might 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 an offer without a contingency using a bridge loan.
You might also need a bridge loan if you’re buying a property that needs significant repairs, but those repairs don’t meet traditional loan guidelines. 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. Manufactured homes are capped at either 50% of the “as-completed” appraised value or $50,000, whichever is less. If your plans don’t meet the criteria, a bridge loan might be a better fit.
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 you sell. Depending on the lender, you may be able to obtain a bridge loan faster than traditional financing, allowing you to snap up a property quickly.
Alternatives to bridge loans
Before you take out a bridge loan, it’s best to consider alternatives such as:
- Home equity line of credit (HELOC). This product is a line of credit based on a percentage of the equity in your home. If approved, you can borrow as much as you need up to your credit line’s limit, so you could potentially borrow enough to make a down payment on your new home and pay off the credit line when you sell your home. 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. If you use a home equity loan as a down payment on a new home, you’ll need to start repaying the loan 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 refinance the mortgage on your current home for enough to pay off your mortgage and make a down payment on a new home. You would need enough equity in your current home to make the transaction work, and you’d still have two mortgages until your current home sells.
- 80-10-10 piggyback loan. With this option, instead of taking out a home equity loan or line of credit on your current home, you take one out on the new home to cover 10% of the down payment. Typically, you take it out at the same time as the mortgage on your new home. You also contribute 10% of the down payment. You’ll still need to pay the mortgage on your current home until it sells.