What Is A Bridge Loan And How Does It Work?

A bridge loan is often used in real estate transactions to provide cash flow during a transitional period, such as when moving from one home into another home. Homeowners can use this type of loan to finance a new home or pay off debt. However, like any form of financing, bridge loans come with certain benefits and drawbacks.

While Rocket Mortgage^® doesn’t currently offer bridge loans, we’re here to help you understand them. Let’s take a closer look at what a bridge loan is and how it works.

A bridge loan is a financing option that serves as a source of funding until you get permanent financing or pay off debt. Also known as swing loans, bridge loans are typically short-term loans, lasting an average of 6 months to 1 year. They can be used to finance the purchase of a new home before selling your existing house.

Most home sellers prefer to wait until their house is under contract before placing an offer on a new house. This way, they can use money from the sale of their current property to help finance a new one. If you’re unable to sell your home, bridge financing can provide you with the necessary funds to move forward with buying a new home.

It’s common for homeowners looking to make a sudden transition to need a way to bridge the gap between homes. A bridge loan can help you finance your way through this transitory time period. If you’re shopping for a new home in a hot market, this loan option can also help you avoid making a sale-contingent offer.

A bridge loan isn’t designed to replace long-term financing in the form of a traditional type of home loan. It’s meant to be repaid within roughly 1 – 3 years. For this reason, a bridge loan is considered a type of non-mortgage or specialty financing rather than a traditional mortgage.

A bridge loan’s terms, conditions and fees can vary greatly from one transaction to another and one lender to another. Some of these loans are designed to pay off your first mortgage at the time the bridge loan closes. Others add new debt onto the overall amount owed.

Costs and payment structure can also vary considerably between lenders. For example, some lenders may require you to make monthly payments. Others may require a mix of upfront and/or end-term or lump-sum payment charges.

Bridge loans tend to:

• Run for a 6-month or yearlong term
• Be secured using the borrower’s current home as a form of collateral
• Only be issued by lenders with whom you agree to finance your new mortgage
• Vary in amounts of interest charged, with charges typically hovering slightly above the prime rate

In general, two main options are available for those seeking a bridge loan. Here’s the breakdown:

• 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.

Here are some additional examples of situations where a homeowner might seek out a residential bridge loan:

• You can’t afford a down payment without first selling your current house.
• You need to quickly secure a new home due to a career transition.
• The closing date for your new home purchase is scheduled after the closing date for the sale of your home.
• You prefer to secure a new property before listing your current one.
• Sellers in your desired area aren’t comfortable with contingent purchase offers.

Applying for a bridge loan works similar to applying for a conventional mortgage. Your loan officer will look at your credit score, credit history and debt-to-income ratio (DTI) when considering your application. Some lenders of bridge loans require a credit score of 740 or higher and a DTI below 50%, but these requirements vary by lender.

The majority of lenders will allow loan applicants to borrow up to 80% of their loan-to-value ratio (LTV). In other words, you’ll typically need at least 20% equity in your current home to qualify. You may also need to meet additional financial qualifications, depending on the lender.

Interest rates for bridge loans tend to be about 2% above prime rate and are generally higher than rates on conventional loans. As with traditional mortgages, bridge loans incur closing costs and origination fees. These can skew up to a few thousand dollars in expenses. You may also be required to pay for an appraisal.

Be advised, though: Protections for buyers are often limited if the sale of their current home falls through. So, it’s important to read the terms and conditions associated with any bridge loan offer. Because bridge loans are secured with your existing property, a lender can foreclose on that property if payments aren’t met.

In light of this, carefully consider how long you can afford to go without financial relief if a sale stalls. Likewise, note how you can avoid overextending yourself on any amounts borrowed. It’s beneficial to do extensive research into the current real estate market and how long homes take to sell in your area.

As with all forms of lending and financing, bridge loans come with advantages and disadvantages. Let’s consider the upsides and downsides to this form of borrowing.

Pros

• A bridge loan offers you the opportunity to buy a new house before you’ve sold your current home.
• You can make an offer on a new home without including a sale contingency.
• It provides additional funds in the event of a sudden or time-sensitive transition.
• It presents a helpful short-term solution for financing your way through periods of uncertainty.
• You may have no monthly payments for the first few months.
• There’s potential for interest-only payments, or deferred payments, until you sell.

Cons

• Bridge loans come with higher interest rates and a higher APR.
• Most lenders require a homeowner to have at least 20% home equity built up.
• Many financial institutions will only extend a bridge loan if you also use them to obtain your new mortgage.
• You may own two houses for a time – and managing two mortgages at once can be stressful.
• Trouble selling your property can lead to future issues, or – in a worst-case scenario – foreclosure.

Bridge loans are available from many lenders, including banks, credit unions and other financial institutions. However, it’s most common for your current mortgage provider to be the originating source for these programs. If you’re interested in pursuing a bridge loan, this lender should be your first call.

Pro tip: As you go about looking for a financing partner, be wary of lenders offering quick access to capital. They may charge excessive rates for their services and fail to present a track record of strong performance or customer service.

Of course, it’s not always necessary to seek out a bridge loan if you need timely capital. After all, many other alternative forms of real estate financing can help you make ends meet. Below, we’ll discuss some examples.

Home Equity Loans

Home equity loans are a popular alternative to bridge loans. Under this form of financing, which is secured using your current home as collateral, you can borrow against your home’s equity. Home equity loans are typically long-term (ranging up to 20 years) and offer comparable interest rates to bridge loans.

A home equity loan is often more affordable than a bridge loan, but this option still requires you to carry two mortgages if you buy a new home and don’t sell quickly. You might consider this option if you're planning on keeping the residence you're leaving for an extended period.

Home Equity Line Of Credit (HELOC)

A home equity line of credit (HELOC) takes the form of a second mortgage. Compared to a bridge loan, a HELOC offers a better interest rate, lower closing costs and added time to repay borrowed sums. You can use any amount borrowed with a HELOC to make home improvements and other upgrades. Note that some HELOCs may come with prepayment penalties.

80-10-10 Loan

An 80-10-10 loan is a financing option that requires less than a 20% down payment and allows you to avoid private mortgage insurance (PMI). Under the terms of an 80-10-10 loan, you pay 10% down then obtain two mortgages: one for 80% of the new home’s asking price, and a second for the remaining 10%. After selling your current home, you can use any funds left over – after paying off any outstanding balances – to pay off the 10% second mortgage.

Personal Loan

Finally, if you have a strong credit history, solid employment, a good payment history and a low debt-to-income ratio, you might consider a personal loan. This kind of loan can be unsecured or secured with a personal asset you offer up to the lender as collateral if you fail to make on-time payments. A personal loan’s terms and conditions will vary by lender.

A bridge loan can come in handy if you need a new home before an old one has sold. It can help you out of a tight spot or help you scoop up a new home in a hot market. A bridge loan can be costly, however.

With a bridge loan, you’ll certainly have more cash in hand to spend on real estate. At the same time, though, you’ll add to your overall debt load. Plus, you may wind up paying off multiple loans simultaneously if your current home doesn’t promptly sell. The best strategy, if possible, is to wait to sell your old house before moving forward to acquire a new property.

If you’re ready to explore any bridge loan alternatives, apply for a home loan with Rocket Mortgage to see what you qualify for.