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.

“A bridge loan is essentially a loan that allows you not to be contingent to sell a home,” said Joseph Elkourie, co-founder and director of operations for Vinci, a real estate group. “It basically allows you to buy a second home now and sell your first home later.”

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.

Types of bridge loans

Lenders may offer different types of bridge loans, such as:

• First-mortgage bridge loans: 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.
• Second-mortgage bridge loans: 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.

Pros and cons of bridge loans

Before taking out a bridge loan, make sure to compare the pros and cons.

Who are bridge loans best for?

Bridge loans are typically best for:

High-income buyers

Bridge loans are usually best for high-income buyers who can afford multiple monthly mortgage payments but don’t have ready cash for a large down payment.

“The people you usually see doing bridge loans are super-high earners with low cash reserves [such as] attorneys, doctors [or] professionals with a guaranteed paycheck who can afford two mortgages but don’t have the capital ready to move quickly,” Joseph Elkourie said.

Real estate investors

Real estate investors might take advantage of bridge loans if they want to capitalize on a rare buying opportunity quickly.

Buyers who need to relocate

Bridge loans can be a good option for people who need to relocate quickly, such as someone who needs to start a new job in a different state.

Considerations before using a bridge loan

Taking out a bridge loan might seem like a smart move for most buyers who currently own property. However, there are some aspects that make them less attractive for most buyers.

Strict requirements

You’ll generally need a very good to excellent credit score, or a FICO score of 740 to 850, to qualify for a bridge loan. You’ll also typically need a debt-to-income (DTI) ratio well below 50%.

High interest rates

Bridge loans tend to have high interest rates that are off-putting to most buyers, usually ranging between 8% and 12%. In comparison, the average 30-year fixed mortgage rate is 6.01%, according to Freddie Mac.

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 one year. Plus, most bridge lenders don’t offer extensions or renewals.

High risk

Bridge loans can be too risky for most buyers since they still rely on you selling your current home. For example, if the market shifts and your first home doesn’t sell for as much as you’d planned, or if it doesn’t sell at all, you could be caught in a financial pinch, especially since bridge loans typically need to be repaid within a year.

Also, bridge loans are typically secured by your equity in your first home, so if you don’t sell your first home within the typical 12-month repayment period, your lender may take possession.

Is a bridge loan right for you?

A bridge loan might 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,” said Mark Milam, founder of Highland Mortgage.

Keep in mind that bridge loans have strict requirements and many risks. 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.

“We don’t see bridge loans very often,” Joseph Elkourie said. “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.”

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.

How to get a bridge loan

Applying for a bridge loan is a lot like applying for a traditional mortgage. Here’s how it typically works:

1. Check your credit and finances

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, so you want to make sure your credit and finances are in great shape.

2. Research lenders

Many financial institutions don’t offer bridge loans, so you’ll have to shop around. Check with local branches of national banks to see if they offer bridge loans for residential properties. However, you may be more likely to find options through local and regional banks or credit unions, as well as online lenders.

3. Compare offers

Be sure to compare terms and rates from multiple lenders so you can find the right option for you. This can be especially important given that bridge loans tend to have higher interest rates and significantly shorter repayment periods than conventional loans.

4. Apply for a loan

Once you’ve found the right loan for you, apply for it online or in person. This will involve submitting personal and financial information. When you’re done filling out the application, submit it.

5. Wait for approval

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.

You and your lender will then arrange a payment schedule. This may be interest-only payments until your first home sells or else fixed payments.

» MORE: Best mortgage lenders

Alternatives to bridge loans

If bridge loans aren’t right for you, there are some alternatives to consider.

80-10-10 loans

Also known as a piggyback loan, an 80-10-10 loan involves making a 10% down payment and then taking out two separate mortgages: one for 80% of the home’s price and another for 10%. Once your current home sells or you build up the capital through other means, you can simply pay off the smaller mortgage.

Personal loans

Personal loans are often cheaper and easier to get, and they offer much longer repayment terms than bridge loans, typically ranging from two to seven years.

Home equity loans

Home equity loans let you borrow against the value of your current home to get a large lump sum for use as a down payment on the second home. Home equity loans have longer repayment terms than bridge loans, though they typically require you to apply before your home is listed for sale.

Home equity lines of credit

Home equity lines of credit (HELOCs) essentially turn the equity you have in your current home into a revolving line of credit, similar to a credit card. You can then use your HELOC to make a down payment on the second property and repay that borrowed amount much later.

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

FAQ

Bottom line

A bridge loan is a special short-term loan that can help you purchase a new home before your current home sells. However, these loans are risky and come with high interest rates and strict borrower requirements, so they’re usually best suited for wealthy buyers and investors who need quick cash for a real estate opportunity. For most homebuyers, a home equity loan or a personal loan might be a better fit.