Everything You Need To Know About Interest-Only Bridge Loans

A bridge loan is a short-term loan that’s used to make a down payment on a new home. A bridge loan can come 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.

An interest-only bridge loan can be a great financing option for homeowners looking to buy a new house before selling their current one These short-term loans allow you to defer the principal payments until the end of the loan term This article provides a comprehensive guide on interest-only bridge loans – how they work, their pros and cons, eligibility criteria, and steps for getting one.

What is an Interest-Only Bridge Loan?

An interest-only bridge loan, also known as an I/O bridge loan, is a type of short-term financing used to “bridge the gap” between buying a new home and selling the old one.

With an I/O bridge loan, you only pay the interest charges each month and defer paying down the principal balance until the end of the loan term. This keeps your monthly payments low during the bridge period.

The loan term usually ranges from 6 to 12 months Once your old home sells, you can pay off the bridge loan using those proceeds You also have the option of refinancing into a traditional mortgage.

How Does an Interest-Only Bridge Loan Work?

Here is a step-by-step overview of how an I/O bridge loan works:

You find a new home you want to buy but haven’t sold your current house yet.
You take out a bridge loan using your current home as collateral, usually for 70-80% of its equity.
The lender provides a lump sum loan amount to cover the down payment on the new home.
During the loan term, you only pay interest – no principal payments. This keeps your monthly payments low.
Once you sell your old house, you pay off the bridge loan in a lump sum.
If you need more time, you can refinance into a conventional mortgage after the term ends.

When To Consider an Interest-Only Bridge Loan

Here are some common scenarios when an interest-only bridge loan can be useful:

You found a new home but need to sell your current house first to afford the down payment.
The new home’s closing date is before you can sell your existing home. An I/O bridge loan provides funds to close on time.
You want to buy a new “hot” listing but need cash quickly to beat out competition. Bridge financing allows a fast close.
You don’t want to put a contingency on the new purchase that your current home must sell first.

Who Offers I/O Bridge Loans?

Many banks, credit unions, mortgage lenders and private money lenders offer interest-only bridge loans. Mortgage brokers can also help you find bridge loan options.

Online lenders like LoanDepot, New American Funding and Axos Bank provide bridge loans nationwide. Brick-and-mortar banks like Wells Fargo and TD Bank also offer bridge financing in the areas they serve.

Be sure to shop around and compare interest rates and fees across multiple lenders. Credit unions and smaller community banks may offer more competitive rates than big banks.

Interest Rates on I/O Bridge Loans

Interest rates on I/O bridge loans are usually higher than rates on conventional mortgages – often 1-3 percentage points higher. This is because it’s a short-term financing option.

Many lenders base the interest rate on the Prime Rate plus a margin. For example, if the Prime Rate is 5% and the lender’s margin is 3%, your bridge loan rate would be 8%.

The interest rate can range anywhere from 5% to 10% for an I/O bridge loan. Your individual rate depends on your credit score, loan amount, and equity in the current home.

I/O Bridge Loan Requirements

Here are some common eligibility requirements for interest-only bridge loans:

Credit Score – Most lenders require a minimum score between 600 and 650. The higher your score, the better the rate.
Down Payment – You’ll need to put down at least 10-20% on the new home purchase.
Equity – You must have significant equity in your current home, usually at least 20-30%. This secures the bridge loan.
Debt-to-Income Ratio – Your total monthly debt payments, including the bridge loan payment, should not exceed 45-50% of your gross monthly income.
Home Value – The current home must appraise for enough to cover the bridge loan amount.

Meeting these requirements ensures you qualify for the lowest interest rate and maximum loan amount to bridge the gap between homes.

Pros of Interest-Only Bridge Loans

Here are some benefits of using an I/O bridge loan:

Lower Monthly Payments – With no principal payments, your monthly costs are reduced significantly during the bridge period.
Access Cash Quickly – You can tap equity in the current home and get funds in as little as 2 weeks for the new down payment.
Avoid New Home Contingencies – Bridge financing allows you to buy the new home without a contingency on selling the old one first.
Pay Only Interest – You avoid principal payments until you sell and pay off the full bridge loan balance.
Short Term – An I/O bridge loan is a temporary solution lasting just 6-12 months in most cases.

Cons of Interest-Only Bridge Loans

There are also some potential drawbacks to be aware of with I/O bridge loans:

Higher Interest Rates – The interest rate is usually 1-3% higher than conventional mortgages.
Limited Protections – If you fail to sell within the term, the lender can foreclose on the collateral home.
Borrowing Limits – Most lenders will only provide 70-80% loan-to-value based on your home equity.
Upfront Fees – You may have to pay 1-2% of the loan amount in origination fees.
Risk of Payment Shock – Principal payments after the term ends can cause payment shock if you don’t pay off the loan.
Credit Score Impacts – A new inquiry and higher credit utilization will cause a temporary drop in your credit scores.

How To Get an Interest-Only Bridge Loan

Follow these key steps to obtain an interest-only bridge loan:

1. Check your home equity – Determine how much equity you have available to tap for the bridge loan. Lenders will only loan up to a certain LTV ratio.

2. Check your credit score – Get copies of your credit reports and make sure your credit scores meet minimum requirements.

3. Shop and compare lenders – Research different banks, credit unions, mortgage lenders and brokers. Compare interest rates, fees, and eligibility criteria.

4. Choose a lender & apply – Select the lender that offers the best loan option. Complete their application and submit required documents.

5. Get pre-approved – The lender will pre-approve you for a maximum I/O bridge loan amount based on your financials and collateral home value.

6. Find & make an offer on a new home – With pre-approval done, you can confidently make an offer and set a quick closing date with the bridge loan funds available.

7. Final loan approval – The lender will give final loan approval and prepare closing documents after the purchase contract is signed.

8. Closing & funding – At closing, you’ll sign final loan documents and the lender will disburse the bridge loan funds to cover your down payment & closing costs.

Alternatives to Interest-Only Bridge Loans

Some other short-term financing options besides I/O bridge loans include:

Home Equity Loan – Tap equity for a lump sum at a fixed rate based on your collateral home’s LTV ratio.
Home Equity Line of Credit (HELOC) – Gets a revolving credit line up to 85% LTV. Draw as needed and pay interest only on what’s used.
Cash-Out Refinance – Refinance your current mortgage and take cash out of the equity for the new home purchase.
401(k) or IRA Loans – Borrow against your qualified retirement savings and pay yourself back with interest.
Personal Loans – Unsecured loans based on income and credit score, not home equity. Usually lower sums with higher rates.
Family Loans – Borrow from relatives if possible. Set clear repayment terms.

Each option has pros and cons to weigh based on your specific scenario. Consider all bridge financing alternatives before deciding what works best for your needs and budget.

The Bottom Line

An interest-only bridge loan can provide an effective short-term financing solution if you need to buy a new home before selling your current one. The interest-only payments keep your costs affordable during the bridge period.

Just be sure to only borrow what you need, shop around for the best rates, and have a solid plan to pay off the full balance within the loan term. With the right approach, an I/O bridge loan can help you transition between

Watch your debt-to-income (DTI) ratio

You’ll need to qualify with both the payments on your current home and the home you’re buying. Think twice about a bridge loan if your income varies due to commissions or self-employment — a few slow months could drain your savings quickly if you’re making three mortgage payments.

How does a bridge loan work?

In many 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:

Hard Money Interest Only Loans

Do bridge loans require monthly payments?

Many bridge loans require interest-only monthly payments and a balloon payment at the end, when the full amount is due. Others call for a lump-sum interest payment that is taken from the total loan amount at closing. A fully amortized bridge loan requires monthly payments that include both principal and interest.

Can a bridge loan be used as a second mortgage?

Some borrowers use the bridge loan as a second mortgage to put toward the down payment on their new home until they can sell their current home. Other borrowers take out one large loan to pay off the mortgage on their old home. Then, they put the remaining money borrowed toward the down payment on their new home.

What happens if a bridge loan has a 2% interest rate?

While interest rates vary, let’s look at the implications of a bridge loan with an interest rate 2% higher than on a standard, fixed-rate mortgage. On a $250,000 conventional loan with a 3% interest rate, you might be paying $1,054 – an amount that would rise to $1,342 with a bridge loan that had a 2% higher interest rate.

What is the interest rate on a bridge loan?

Bridge loan interest rates typically range between 6% to 10%. Meanwhile, traditional commercial loan rates range from 1.176% to 12%. Borrowers can secure a lower interest rate with a traditional commercial loan, especially with a high credit score. However, that means enduring a long processing time of at least 3 months. What do lenders look for?