What is a bridge loan?
Updated 9:26 p.m. UTC July 16, 2023
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Key points
- If you start the process of buying a new property while your current one remains on the market, a bridge loan can make up the financial difference.
- While bridge loans can be expensive, they can make the moving process go more smoothly and give you an advantage over other buyers.
- Be sure to understand the costs and risks associated with bridge loans before applying for one.
If you own your current home and are planning on moving into a new one, a bridge loan can help make the transition go more smoothly, particularly if the closing dates on the sale of your current home and the purchase of your new one don’t match up.
A bridge loan is a form of short-term financing that can help you purchase your new home when you don’t yet have access to the equity from your current home. The loan essentially allows you to tap into that equity to aid in the financing of the new home.
How does a bridge loan work?
A bridge loan is typically available to help you buy a new home while you wait for the sale of your existing home. You can typically borrow up to 80% of the combined values of both homes, giving you a couple of options:
- Use the loan as a second mortgage to put toward the down payment and closing costs on the new home.
- Pay off the mortgage loan on your current home and use the remainder for a down payment and closing costs on the new home.
This loan, which uses your first home as collateral, typically has repayment terms ranging from six months to one year. You’ll typically repay the loan when you receive the proceeds from the sale of your first home. However, some lenders may offer other repayment options, which may require monthly payments for a set period and a balloon (or big) payment at the end of the term.
“With a bridge loan, both homes must be your principal residence, unlike a traditional mortgage where you can buy or refinance a rental property or vacation home,” says Henry Brandt, senior vice president of branch development at Planet Home Lending.
The primary reason to consider a bridge loan is that you don’t have to make your offer on the new home contingent upon the sale of your current one. Contingency-free offers are attractive to sellers because they pose less of a risk of falling through.
Because bridge loans are short-term in nature, lenders don’t earn much money from servicing the loan. As a result, they typically charge higher interest rates than what you’d pay on a traditional mortgage loan. These loans also come with their own set of closing costs.
Example of a bridge loan
Let’s say that you’re in a seller’s market, so you can sell your house relatively quickly but may find it difficult to land a contract on a new home.
The home you’re selling is worth $300,000, and you have a $200,000 mortgage on it. The home you’re planning to buy is worth $400,000. As a result, you can borrow up to $560,000 with a bridge loan (that’s 80% of the combined values of both homes).
Keep in mind, though, that when you sell your existing home, you’ll ideally get enough from the sale to pay off the bridge loan in full. So, you’d likely want to borrow far less than $560,000. In the scenario above, for example, you might take out a bridge loan of, say, $280,000. That would allow you to pay off the $200,000 balance on your current mortgage and make an $80,000 (or 20%) down payment on your new, $400,000 property.
Pros and cons of bridge loans
There are both benefits and drawbacks to using a bridge loan to make the transition into a new home. Here’s what you should keep in mind as you consider whether it’s the right fit for you.
| PROS | CONS |
|---|---|
Can help in a seller’s market: If you’re competing against other buyers for a home, a bridge loan allows you to make a contingency-free offer, which can give you an advantage over the competition.
| Expensive: Bridge loans carry higher interest rates than traditional mortgage loans, so you’ll want to try to sell your home as quickly as possible to pay off the debt. You’ll also pay more closing costs with an extra loan than if you were to wait until you’ve sold your home and apply for just one new mortgage loan.
|
Can help you avoid private mortgage insurance: Even if you have enough equity in your current home to put down 20% or more on your next one, you’ll still have to pay private mortgage insurance (PMI) on the new loan if you don’t have those funds right now. With a bridge loan, you can make that down payment and avoid the cost of PMI.
| More monthly payments: Depending on how you use your new bridge loan, you could have up to three monthly housing payments. Make sure you run the numbers and can afford to take on this new debt.
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Makes for a faster process: If you’re ready to buy and move into your new home, you don’t have to wait until your current one sells. A bridge loan gives you the flexibility to move even if you don’t yet have a buyer. “You can time the two closings, so you don’t have to sell your current home and move before your new home purchase closes,” says Brandt.
| You may not qualify: You typically need to have at least 20% equity in your current home to qualify for a bridge loan, and you’ll also need to be able to meet other credit requirements, which can vary by len
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Frequently asked questions (FAQs)
One of the biggest risks of a bridge loan is if you can’t sell your current home before you need to start making payments. If your budget doesn’t have enough room for this additional payment, you may end up defaulting on the debt. If that happens, the lender of the bridge loan can foreclose on your first home. “Even though you’re only paying the bridge loan for a short time, compare the rate, fees and total costs, just as you would for a traditional mortgage,” says Brandt.
The application process and funding timeline can vary by lender, but it typically takes between 30 and 45 days to close on a bridge loan. To avoid delays, provide any information and documentation your lender requests as quickly as possible.
Depending on your situation, you may be able to use a home equity loan, home equity line of credit (HELOC) or a piggyback loan to help you with the down payment on your new home. The first two may be particularly beneficial if you’re not planning to sell your current home and want to use it as an investment property instead. A piggyback loan is a second mortgage, which you can use on its own or with some of your cash reserves to meet the 20% down payment requirement needed to avoid PMI.
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