If you want to invest in real estate, a bridge loan can be a great source of financing for you. A bridge loan is a kind of short-term loan that can have a term of anywhere from two weeks to three years. However, the majority of bridge loans last for six months to 12 months. When taking out this type of loan, you’ll be provided with short-term funding that you can use to close on a property that you’re investing in or purchase another property while you wait for your current one to be sold.
Many homeowners encounter a two-step transaction that involves purchasing a new building while trying to sell an old one. You should consider seeking a bridge loan when you need to bridge two separate financial transactions. If standard bank financing isn’t available to you, or you need to move quickly to close on a transaction, a bridge loan may be your best bet. This article takes a closer look at how bridge loans work as well as the pros and cons of this specific type of loan.
A bridge loan allows you to buy a new home before selling your existing one This type of financing serves as a short-term solution to bridge the gap between closing on a new home and selling the old one But is taking out a bridge loan a smart move? Here’s what you need to know to decide if a bridge loan is right for your situation,
What is a Bridge Loan?
A bridge loan, also called a swing loan, is a short-term loan that provides temporary financing until permanent financing is secured. Bridge loans are commonly used in real estate transactions to cover costs when buying a new home before selling an old one.
The loans typically last for 6 months to 1 year and are repaid once the old home is sold or permanent financing is obtained The bridge loan is secured by the equity in the current home and acts as a “bridge” to span the time between closings on the two properties
When Might a Bridge Loan Make Sense?
There are a few scenarios where a bridge loan can be a helpful tool:
-
You’ve found your dream home but need to sell your current house first. In a competitive market, sellers may not accept offers contingent on the sale of your existing home. A bridge loan allows you to buy the new home outright while giving you time to sell the old one.
-
You don’t have enough for a down payment until you sell, Tapping home equity with a bridge loan can provide funds for the new home’s down payment and closing costs before the current home sells This allows you to buy sooner
-
Your closing dates don’t line up. If the closing date on your new home falls before the closing date on the sale of your current home, a bridge loan can cover the timing gap.
-
You want flexibility in listing your home. With a bridge loan, you can move into the new house and sell the old one at your own pace rather than rushing to list it before you move.
What are the Drawbacks of a Bridge Loan?
Using a bridge loan isn’t always the best choice. Consider these potential downsides first:
-
Higher costs. Bridge loans typically have higher interest rates and fees than traditional mortgages. You’ll also incur costs for appraisals, credit checks and loan processing.
-
Risk. If your home doesn’t sell quickly enough, you’ll be stuck paying two mortgages. And if you can’t sell at all, you could lose both homes.
-
Tight qualifications. You’ll likely need pristine credit, significant equity and cash reserves to qualify. Income requirements may be higher too.
-
Short repayment terms. The loan must be repaid rapidly, usually within 12 months. This timeline might not match up with how long it takes to sell.
-
Prepayment penalties. Some bridge loans charge expensive prepayment penalties if you repay the loan early after selling your home quickly.
What are the Costs?
Bridge loans carry higher interest rates and fees than conventional mortgages. Here are some typical costs:
-
Interest rates – Usually 2% to 5% above prime rate
-
Origination fee – Up to 5% of the loan amount
-
Other fees – Application fees, appraisal fees, attorney fees
-
Closing costs – Similar closing costs as a traditional mortgage
In total, fees can add up to thousands of dollars. And if the loan is tapped for its full term, you’ll pay significantly more interest than with a conventional mortgage.
What are the Qualifications?
Bridge loan qualifications are stricter than for standard mortgages. Typical requirements include:
-
Credit score – 720 or higher
-
Debt-to-income ratio – Below 50%
-
Down payment – At least 20% equity in current home
-
Assets – Significant cash reserves after down payment
-
Employment – Strong, consistent income history
Meeting these standards ensures you can comfortably handle both mortgage payments during the bridge loan term.
How Does the Process Work?
Getting a bridge loan involves many steps:
- Initial consultation with a loan officer
- Completing a detailed application
- Providing documentation of income, assets, debts and credit
- Getting an appraisal on the current home
- Underwriting review and approval
- Securing hazard insurance for both properties
- Final loan closing and receiving loan proceeds
The entire process can take 30-60 days. It’s critical to select an experienced lender who can guide you through the many requirements.
What About Alternatives?
Other short-term financing options exist too, like home equity loans or lines of credit. These may charge lower rates and fees.
Or, you can simply buy first with a conventional mortgage, then sell and pay off the new loan after closing. This avoids a second loan but requires qualifying for both mortgages.
If possible, timing the closings so you sell before you buy is ideal. Then you can use cash from the sale for the new home purchase.
Key Takeaways
Bridge loans fill a unique niche but aren’t a solution for everyone. Consider the pros and cons and your specific situation. Get prequalified to see if you meet the strict requirements before pursuing this path.
A bridge loan can be the right choice if:
- You need flexible timing between selling and buying
- You find a must-have home but need to sell yours first
- Your new home’s closing is before your sale’s closing
But a bridge loan may not be advisable if:
- You can qualify to buy first with a traditional mortgage
- You can align closing timelines for simultaneous closings
- Bridge loan costs and risks outweigh the benefits for you
Bridge loans provide a valuable option. But exhaust all alternatives before deciding if this specialized financing route aligns with your home buying and selling plans. With thorough planning and research, you can determine if a bridge loan is a wise idea for your situation.
How Bridge Loans Work
When looking at how bridge loans work, they usually have the same requirements as a standard mortgage. For one, you’ll need to have at least some equity in the property in question. Let’s say you have a home that’s worth $500,000 but still has $300,000 left on the mortgage. You would have $200,000 in equity. The loan needs to be backed by collateral, which is why it’s important that you have access to equity.
The terms of your bridge loan will likely last for around six to twelve months until you will be required to pay back the loan. These loans are designed specifically to be used on a short-term basis to assist you during a period of transition. Keep in mind that the majority of lenders that can provide you with bridge loans won’t go higher than a loan-to-value ratio of 70 percent, which means that you will need to maintain at least 30 percent equity within the current asset that you own in order for a bridge loan to be provided to you.
There are many reasons why it could be ideal for you to obtain a bridge loan, which includes:
- It will provide a safety net in the event that you sell your old home before purchasing a new one so you won’t have to rent
- Allows the purchase of a new home, without notable restriction, while placing a current home on the market
- Being able to put a down payment on a new home without using the profits from selling your old one
- Payments can be deferred or interest-only until you are able to sell your old home, which provides a certain amount of flexibility
While bridge loans can be beneficial for a variety of situations, there are some negatives to this type of loan that you should consider before applying for one. These cons include:
- Bridge loans have exceedingly short lifespans and require a significant amount of work from the lender, which is why the loans can have relatively high-interest rates that can be around 8.5-10.5 percent of the complete loan amount
- The closing costs and fees pertaining to this loan can be high and may drive up your costs
- The lender that provides you with the loan could decide to use a variable prime rate, which means that your interest rate would increase over time
- There’s always the possibility that your home wouldn’t be able to be sold during the six to twelve month term of the loan, which would put you in a problematic situation
- These loans are generally considered to be more expensive than a traditional home equity loan
Bridge Loan vs. Home Equity Loan
Before you consider applying for a bridge loan, it’s recommended that you compare bridge loans with home equity loans, which are somewhat similar in how they work. Just like bridge loans, a home equity loan is secured, which means that your current home will be used as collateral. While it might sound risky to use your home as collateral, you should have enough time to sell the current property before the term of the loan ends.
While both of these loans are considered to be secured loans, they are otherwise very different. For one, home equity loans are generally long-term loans. The majority of these loans will come with longer repayment periods that can last anywhere from 5-20 years, which is much higher than the six to twelve months that is standard with a bridge loan. Because of the longer terms with home equity loans, interest rates are typically lower as well. If you are able to effectively qualify for a standard home equity loan, you can expect the interest rates you pay to be around six percent, which is decidedly lower than the 8.5-10.5 percent that comes with bridge loans.
A home equity loan is actually riskier for you when compared to a bridge loan. While bridge loans also come with the risk of being unable to sell the property, a home equity loan puts you at the risk of paying for three separate loans in the event that your old home doesn’t sell on time, which include the original mortgage, the new mortgage, and the home equity loan that you’ve received.
If you’ve built up a significant amount of equity in your current home by paying a substantial amount of the old mortgage, a home equity loan might be the better option for you. There are risks to both loan options that you should keep in mind. However, a bridge loan is typically the better option as long as it fits with your situation.
What is a bridge loan – How do bridge loans work?
FAQ
What are the downsides of a bridge loan?
What is the truth about bridge loans?
What is the main advantage of a bridge loan?
What is the average interest rate on a bridge loan?
Should I get a bridge loan?
You can get a real, customizable mortgage solution based on your unique financial situation. A bridge loan can appear to be a good solution if you’re in a situation where you want to buy a new home but still have an obligation on the home you still own and need to sell.
Are bridge loans worth it?
A bridge loan is definitely worth considering for borrowers who are trying to buy and sell a home at the same time. Also called a “wrap” or “gap financing,” bridge loans are a lifeline for home buyers who are eager to purchase new digs before they’ve sold the home they’re currently in.
Can a bridge loan help you buy a new house?
Buying and selling a home simultaneously: If you’re counting on the proceeds from a home sale to purchase a new property (and you’ve already found the new house), a bridge loan can provide temporary financing or help you afford the payments on the additional mortgage.
When is a home bridge loan a good fit?
Home bridge financing is used most often when a homeowner plans to buy a new home before selling their current one. A bridge loan might be a good fit if: You found a new home, but the seller won’t accept a contingency offer to sell your current home.