What is a bridge loan?

How bridge loans work

A bridge loan is a special type of short-term loan that can help finance a new purchase while a previous debt obligation is still being paid off. In real estate, a bridge loan can bridge the gap between the sale of your existing home and the purchase of your new home.

For example, let’s say you want to buy Property B, but your current home, Property A, hasn’t sold yet. You can apply for a bridge loan secured by Property A to purchase Property B, and once Property A sells, you can apply the sale cash to the balance of your bridge loan.

“A bridge loan is essentially a loan that allows you not to be contingent to sell a home,” Joseph Elkourie, an associate broker for the luxury real estate group Vinci, told ConsumerAffairs. “It basically allows you to buy a second home now and sell your first home later.”

In the past, bridge loans have been popular with:

• Buyers who need to relocate quickly (e.g., to start a new job in a different state)
• High-income buyers who can afford multiple monthly mortgage payments but don’t have the cash for a large down payment
• Real estate investors who want to capitalize on a rare buying opportunity

But there are multiple reasons why bridge loans have become less common, even among these niche groups. Most of it comes down to the associated costs.

»MORE: How to buy a second home

The cost of bridge loans

On the surface, taking out a bridge loan might seem like a smart move for most buyers who currently own property. Who doesn’t want another six to 12 months to sell their home? However, here are a few caveats to bridge loans that may make them less attractive to your average homebuyer:

• High interest rates: Bridge loans tend to have high interest rates that are off-putting to most buyers. For instance, the average 30-year fixed mortgage rate was around 7% during the first half of August 2023, according to Freddie Mac. In the same period, the average bridge loan rate was between 9.5% and 12%, according to the mortgage lender Vaster.
• High closing costs: Bridge loans, which can be used to help cover closing costs for a new mortgage, also have their own closing costs. You may pay thousands of dollars in application fees, origination fees and attorney’s fees, and your bridge lender may even require a separate appraisal.
• Short repayment periods: While a traditional mortgage gives you 30 years to pay off your debt, bridge loans must usually be repaid within 12 months. Most bridge lenders don’t offer extensions or renewals, so you have a relatively tight window of time to come up with a big pile of capital plus interest.
• High risk: Due to their high interest rates and short repayment periods, bridge loans can be too risky for most buyers and are still heavily contingent on you selling your current home eventually. For example, if the market shifts and your first home doesn’t sell for as much as you’d planned — or doesn’t sell at all — you could be caught in a financial pinch.

“We don’t see bridge loans very often for these reasons,” said Elkourie. “What usually happens is we start a dialogue about bridge loans, but when people understand how difficult and expensive they are, they’ll usually resort to the status quo of buying a new home while simultaneously selling their old one.”

But bridge loans can still be a useful tool for wealthy, risk-tolerant buyers. According to Elkourie, “The people you usually see doing bridge loans are super-high earners with low cash reserves … attorneys, doctors, professionals with a guaranteed paycheck who can afford two mortgages but don’t have the capital ready to move quickly.”

»MORE: How to sell and buy a house at the same time

When to use a bridge loan

A bridge loan can make sense if you absolutely need to buy a new home before your current one can sell, but you don’t have the time to gather the cash required to make an offer.

In terms of timing, you’ll want to start applying for a bridge loan before you make an offer on a new property.

“Getting approved for a bridge loan enables you to make a no-contingency offer, which is much more attractive to the seller,” Mark Milam, the founder of Highland Mortgage, told ConsumerAffairs.

Just keep in mind that the requirements for bridge loans are stringent. You’ll need excellent credit, enough steady income to make multiple mortgage payments simultaneously and a high risk tolerance in case you can’t pay off your bridge loan within a year.

If you’re starting to think a bridge loan isn’t for you but you’re not sure how you’re going to afford a 20% down payment, here are three things to keep in mind:

• The average down payment on a home isn’t 20% anymore. It ranges from 6% to 17%, according to the National Association of Realtors.
• Some of our picks for the best mortgage lenders accept minimum down payments well below 10% for qualified buyers.
• There are several cheaper and easier alternatives to bridge loans that may be available to you as long as you haven’t yet listed your first home for sale.

Pros and cons of bridge loans

Before taking out a bridge loan, make sure to compare the key advantages and drawbacks of getting one for your next home.

How to get a bridge loan

Applying for a bridge loan is a lot like applying for a traditional mortgage. Your loan officer will pore over every detail of your finances, including your credit history, debt-to-income ratio, net worth, investments, sources of income and more.

Needless to say, you’ll need a very good credit score (740+) to qualify for a bridge loan, as well as a debt-to-income ratio well below 50%.

If approved for a bridge loan, you’ll typically be allowed to borrow up to a maximum of 80% of the combined value of both homes. That’s why lenders usually require you to have at least 20% equity in your current home to qualify.

Some lenders offer two different bridge loan options:

1. First-mortgage bridge loans can pay off your first mortgage and cover the down payment on your second home. You’ll then pay off a large bridge loan until your first home sells.
2. Second-mortgage bridge loans involve borrowing just enough to cover the down payment on your new home. This means you’ll be paying off your first mortgage, your second mortgage and a smaller bridge loan all at once.

Finally, you and your lender will arrange a payment schedule. You may have multiple options, including interest-only payments until your first home sells or fixed payments regardless. However, none of those payments will be small, which is why it’s best to approach bridge loans with plenty of planning and caution.

» MORE: How to apply for a mortgage

Alternatives to bridge loans

If you’re seeking quick access to capital but bridge loans aren’t the right tool, there are some alternatives to consider. While these alternatives are generally easier to get than bridge loans, the interest paid over time with these longer-term loans can potentially be tens of thousands of dollars higher.

Bottom line

A bridge loan is a special short-term loan that can help bridge the gap if you need to purchase a new home before your current home sells. The high risks, high interest rates and extremely high borrower requirements associated with bridge loans make them suited to wealthy buyers and investors who need quick cash to take advantage of an opportunity. But for most homebuyers, a home equity loan or personal loan might be a better fit.