What is a bridge loan?

A bridge loan is a sum of money that the bank loans to cover the interim period between two transactions, usually the buying of one home and the selling of another. They’re “secured” loans, meaning you have to put up collateral (usually the existing home) so the lender’s interests are protected.

Bridge loans arise most often when a homeowner buys a different house before she’s sold her current home. The loan “bridges” the period when she owns two homes.

If you hear the terms “bridging financing,” “bridging loan,” “swing loan,” “gap financing” or “interim financing” they’re all the same thing: bridge loans.

How does a bridge loan work?

Home sellers are currently in a strong position to hold out for the best possible deal. And they’re much less likely to wait for a buyer to sell his existing home.

A bridge loan helps with cash flow and gives the buyer the ability to make an offer that is not contingent on selling a home thereby having better odds of getting the offer accepted.

Two common types of bridge loans

You can use bridge loans in a couple of ways. If you can afford it, you can borrow the down payment on the new property and then carry the costs of two mortgages and the bridge loan. Or you might be able to pay off your entire first mortgage, plus your down payment on the new house, with a bigger bridge loan.

Typically, these loans don’t require monthly payments (or they may have smaller, interest-only ones), at least for the first few months. Instead, they’re usually repayable in full — including accrued interest if you haven’t been paying that as you go along — when you close on your sale.

Advantages of a bridge loan

There’s a lot to like about a bridge loan, especially in a seller’s market. It can be the difference between buying your dream home and having to accept the second best.

Because it gives you a new level of buying power. With one of these in your pocket, you’re free to sign a purchase agreement without contingency.

Better yet, it can be affordable. Many bridge loans have no monthly payments. And others require only that you keep up with the interest due. Of course, you have to pay back the borrowing. But you can do that out of the proceeds of the sale of your existing home.

Drawbacks of a bridge loan

These loans have real advantages, especially if they’re your only route to buying your perfect next home. But it’s important to recognize their downsides. Here are five:

1. They’re not cheap. Forbes reckons bridge loan rates typically ranged from 8.5% to 10.5% in mid-2020. Another source widens the range: 6% to 10%. Both those are higher interest rates than most forms of secured borrowing, including mortgages, home equity loans, and home equity lines of credit (HELOCs).
2. You’ll own (and be paying for) two homes until you sell your existing one.
3. They’re not easy to qualify for. Expect to need a significant equity cushion. In other words, your current mortgage balance will need to be no more than 80% of your home’s appraised value; the lower the better. And you’ll also need a decent credit score and probably few existing debts.
4. Most bridge loans are limited to one year. Bridge loans are a form of short-term financing so it’s you’ll likely need to begin repayment within a year. And, if you need to, you may find it harder to refinance when that time’s up. Not all hold off on monthly payments for the entire term. So, if that’s important to you, make sure yours does.
5. They carry risk. With luck, the property market won’t crash (making home prices tumble) during the period you own two houses. And, right now, that looks highly unlikely. But you won’t find anyone credible who’s willing to guarantee it.

Those are some serious drawbacks. Of course, most people who use bridge loans presumably believe they were worth it.

But don’t completely ignore your head and listen to your heart. You’re borrowing a lot of money and that always deserves sober consideration.

When to use a bridge loan

You should use a bridge loan only when you can afford one — and when you’re as confident as you can be that home prices are going to hold up where you’re buying and selling.

So let’s assume those are a given. When are the times when you’re most likely to need one?

Well, when you want to buy a home before you’ve sold your existing one. But more specifically, this includes:

During a seller’s market

During a seller’s market, buyers are at a real disadvantage. The seller’s real estate agent might receive several offers at the same time. And any contingent offers that are dependent on the home buyer selling her existing home are likely to be ignored.

Then the usual hierarchy will apply:

1. Cash buyers
2. Those with a pre-approval letter from a lender (that lender’s comprehensively checked out your finances)
3. Buyers with pre-qualification letters (the lender’s relied on what you’ve told it, so this is less compelling than pre-approval)
4. People who haven’t even begun to line up their financing

Of course, you may be able to buy a higher place on that hierarchy by making a bigger offer but not always.

So, if you’re unable to move forward until your home sells, you may have only one choice. And that’s to quickly find a bridge loan.

When you don’t have enough saved for your down payment

Of course, if you have sufficient savings, you might not need a bridge loan because you’re already in a position to make a healthy down payment without getting another mortgage loan.

But few people have that sort of lump sum immediately available in a savings account. For borrowers whose assets are tied up in less liquid investments, a bridge loan may still be preferable to cashing out high-yield assets.

How to get a bridge loan

Bridge loans have high “underwriting” standards. That means you’ll need to be a creditworthy borrower with sound finances to qualify for one. This is because any lender will want to be sure you can comfortably afford the payments on multiple simultaneous loans.

Of course, smart people make sure their finances are in the best shape possible before they begin to search for a new home. So you are likely already in a good position to apply and get approved by a bridge loan lender.

How to find a lender that offers bridge loans

First, reach out to your bank or credit union. If that doesn’t work, cast your net a little wider and look at other banks and credit unions.

Don’t expect mainstream mortgage lenders to offer bridge loans. However, some lenders that offer non-qualified mortgages (non-QM loans) do offer them. Non-qualified mortgages are loans where many of the rules on mainstream mortgages don’t apply: things like interest-only mortgages and ones with balloon payments.

But what if all those decline your applications? Well, you might also be tempted by “hard-money lenders.” These are groups of investors who look for high returns from often-desperate borrowers. They are not all bad but you should check out any you’re considering dealing with very carefully before you commit.

The cost of a bridge loan

Bridge loans aren’t cheap. That’s because lenders recognize the risk involved when a borrower is juggling multiple loans, especially if your existing home doesn’t sell quickly.

Interest rates for bridge loans are high: usually in the 6% to 10% range. And fees are similarly pricey. Expect to pay between 1.5% and 3% of the loan amount.

So, as always when you’re borrowing a big sum, shop around for your best deal.

Finally, be wary of any lender that requires you to pay fees upfront. They’re normally due when the entire loan becomes payable after you close on the sale of your existing home.

Alternatives to a bridge loan

Let’s assume you don’t have the savings or easily accessible assets to fund the purchase yourself. Here are the three main alternatives to a bridge loan:

• HELOC. A home equity line of credit is a kind of second mortgage. It may be less expensive (though not in all circumstances) and more flexible. You pay interest only on the amount you’re borrowing when you’re borrowing it. And fees may be more modest than a bridging loan. However, again, that will depend on you and other circumstances so you should shop around.
  
• 80-10-10 mortgage. This might be a good choice if you have only enough savings for a 10% down payment on your new home. If you borrow the other 10% to make a 20% down payment then you can avoid mortgage insurance.
  
• Personal loan. These days, personal loans can offer highly qualified borrowers large, six-figure loans at attractive rates. And you may pay low or zero fees. But these deals are only available to those with great credit scores and highly stable finances.

Be sure to consider these options before you make a final decision about a loan.

FAQ

Who is eligible for a bridge loan?

Mainstream lenders look for high-quality borrowers with glowing credit reports, plenty of equity and robust personal finances.

If that’s not you, you may be able to find a hard-money lender that will approve you. But expect significantly higher rates and fees. And be sure to check out your lender very carefully to make sure it’s reputable and ethical.

How much can you borrow on a bridge loan?

There are no formal caps on the amount you can borrow. However, expect lenders to satisfy themselves that you can comfortably afford the extra financial burden that comes with a bridge loan.

You’ll also be limited by the amount of equity you have. Some lenders want you to borrow in total no more than 80% of the value of both homes combined.

How long does it take to get a bridge loan?

Mainstream lenders tend to recognize that time is of the essence in these circumstances. Still, they can still take 30 days+ to let you have the money. More often, you may be looking at two weeks.

Of course, if you think you may need a bridge loan, you can begin the comparison shopping and application processes before you begin hunting for a new home.