Bridge Loan: What It is and How It Works
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.
What is a bridge loan?
A bridge loan, also known as a swing loan or gap loan, acts as a “bridge” between selling your current home and buying a new one. A bridge loan is a short-term mortgage secured by a portion of the equity in your current home, even if it’s for sale, to use toward the down payment on a new home. Your home equity is the difference between your home’s value and the balance of your mortgage.
Bridge loans are a good alternative to a cash-out refinance, which doesn’t allow you to borrow against your current home’s equity if it’s listed for sale. Bridge loans also help with the balancing act of buying and selling a house at the same time.
When you need a bridge loan
Some common scenarios that a bridge loan may help with include:
- A new home purchase in a hyper-competitive market. When there are multiple bidders for a home, sellers aren’t as likely to accept an offer contingent on the sale of your home. However, if you need the funds from your current home to make your new-home payment affordable, a bridge loan may help you get enough cash to bridge the gap until your home sells.
- A fixer-upper home purchase. If you’re buying a property that needs significant repairs, but those repairs don’t meet traditional loan guidelines, a bridge loan may help. For example, Fannie Mae’s HomeStyle® Renovation loan limits renovation funds to either 75% of the purchase price plus renovation costs or 75% of the “as-completed” appraised value, which may not be enough funds to buy and fix up the home. A bridge loan might give you the extra money needed to complete the renovations without dipping into your savings account.
- A fix-and-flip home purchase. A bridge mortgage is worth considering if you’re fixing and flipping a home. If everything goes according to plan, you can repay the loan when renovations are complete. You may be able to obtain a bridge loan faster than traditional financing, allowing you to snap up a property quickly.
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:
You’ll need to choose whether the loan is a first or second mortgage
You can borrow more than you currently owe and pocket the difference with one mortgage, or you can take out a smaller loan against a portion of your home’s equity with a second loan.
Here’s how each works:
- First-mortgage bridge loan. A lender offers you one loan to pay off the balance of your mortgage plus enough for a down payment. Your current mortgage is paid off, and the bridge loan takes first position until you sell your current home, at which point you pay off the loan.
- Second-mortgage bridge loan. A lender offers you a loan in the amount you need for a down payment on your new home, but leaves your current first mortgage balance alone. The loan is secured by your current home, which makes it a second mortgage.
You’ll typically be able to borrow up to 75% of your home’s value
Whether you take out a first- or second-mortgage bridge loan, you won’t be able to tap all of your home’s equity. A bridge loan may not make sense if you don’t have more than 20% equity.
You may have options for how you make your monthly payment
Depending on the lender’s terms, you may make interest-only monthly payments, no payments until the home is sold or fixed monthly payments.
You’ll pay closing costs and possibly have a prepayment penalty
Expect to pay 1.5% to 3% of the loan amount in closing costs for a bridge loan. Additionally, bridge loan rates can be as high as 6.99% to 8%, depending on your loan amount and credit profile. Steer clear of any lender that asks for an upfront deposit for a bridge loan; you’ll pay all bridge loan fees when the mortgage closes. Check your bridge loan terms for a prepayment penalty.
You need to be prepared to pay the loan off within a short time period
A bridge loan usually needs to be repaid within 12 months or less. If you’re having any doubts about selling your home within that time period, you may want to consider buying your new home with piggyback financing instead. You can split your mortgage up into a first mortgage amount that gives you the payment you want, and then borrow the difference with a second mortgage home equity line of credit or home equity loan. When you sell your home, you’ll pay off the second mortgage balance, leaving you with just the first mortgage payment.
You won’t have the same legal protections as a standard loan
Unlike standard mortgage loans, bridge loans aren’t covered by the Real Estate Settlement Procedures Act (RESPA), which sets standards for informing consumers about settlement costs and how lenders are paid. Make sure you shop around for the best bridge loan terms – they may vary significantly from lender to lender.
Bridge loan example:
Below is an example of the math involved in a bridge loan for the following situation:
- you buy a home priced at $400,000
- your current home is worth $350,000
- you owe $150,000 on your current mortgage and
- the bridge loan company gives you two options to lend you 80% of your home’s value
- A new first mortgage that replaces your first mortgage to give you cash back
- A new second mortgage that’s added to your first mortgage to give you cash back
| First-mortgage bridge loan | Second-mortgage bridge loan | |
|---|---|---|
| Current home | $350,000 current value X .80 (80% of value) __________________________ $280,000 first-mortgage bridge loan ($150,000) current mortgage payoff __________________________ $ 130,000 cash back for new purchase | $350,000 current value X .80 (80% of value) __________________________ $280,000 maximum both loans ($150,000) current loan balance _________________________ $ 130,000 second-mortgage bridge |
| New home | $400,000 ($130,000) bridge loan down payment __________________________ $270,000 needed for new home | $400,000 ($130,000) bridge loan down payment __________________________ $270,000 need for new home |
Bottom line: In the example above, a bridge loan converts $130,000 of your home’s equity to cash you can use to purchase your new home while you wait for your current home to sell.
Even though the amount of cash you receive is the same in each example, the difference is how many mortgage payments you’re left with on your existing home. A first mortgage bridge loan pays off your existing mortgage balance, leaving you with just your bridge loan payment on the home you’re selling. The second mortgage bridge loan leaves the balance on the existing mortgage untouched but adds a second lien, which means you’ll make two payments on your home until it is paid off.
How to get a bridge loan in 5 steps
1. Check your home equity
You’ll need at least 20% equity to get a bridge loan in most cases, but much more than that if you need to net extra cash for a down payment on a new home. Keep in mind, if your home sells for less than you expected, you could end up having to pay off the bridge loan balance with cash.
2. 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.
3. Boost your credit scores
Bridge lenders want to see that you’ve handled your debt responsibly since they know you’ll likely be paying multiple mortgage payments. A high credit score will get you the best rates, although some bridge loan programs allow scores as low as 600.
4. Find a bridge loan lender
Bridge loans are a specialized product, and not all lenders offer them. Ask the lender you’re working with for the new home purchase about whether it offers bridge loans. If it doesn’t, consider these options:
- Local banks and credit unions. If you already bank with a local institution, ask about bridge loans. Even if you don’t bank with them, local banks and credit unions offer personal service and understand your local real estate market.
- Non-QM lenders. Non-qualified mortgage (non-QM) lenders specialize in alternative mortgage products like bridge loans. Non-QM loans have features that aren’t allowed in qualified mortgages, like interest-only and balloon payment structures.
- Hard-money lenders. Hard-money lenders are individuals or groups of investors who offer loans with short repayment terms, like bridge loans. They tend to have higher interest rates, but they may not be as stringent when it comes to credit requirements. Confirm the lender is reputable before working with one.
THINGS TO KNOW
Verify that any loan officer or institution you’re considering is appropriately licensed by visiting the Nationwide Multistate Licensing System (NMLS) Consumer Access website. You can search by loan officer or company name and confirm they’re licensed in your state.
4. Have a bridge loan payoff backup plan
Getting a bridge loan can be risky if home values start to drop, so make sure you have the assets to pay it off if for some reason you can’t sell your home. You could lose your home to foreclosure if you don’t or can’t pay it off within 12 months.
Pros and cons of bridge loans
| Pros | Cons |
|---|---|
You can use your current home equity while it’s listed for sale to buy a new home | You’ll pay high interest rates and closing costs |
You won’t clean out your savings account | You could have up to three monthly mortgage payments for a period of time |
You can make offers without contingencies for the sale of your current home | You could lose both homes if you can’t make payments and the bridge lender forecloses |
You may be able to make interest-only mortgage payments | You may have a harder time finding a bridge lender |
You can make a larger down payment on the home you’re buying using your current home’s equity | Your loan may be considered riskier with fewer federal protections |
Bridge loan alternatives
Before you take out a bridge loan, consider alternatives such as:
- Home equity line of credit (HELOC). This mortgage product works like a credit card. If approved, you can borrow as much as you need up to your credit line’s limit. Many HELOCs offer the same interest-only bridge loan payment option. Like a bridge loan, this alternative uses your home as collateral.
- Home equity loan. With this alternative, you borrow against a portion of your home’s equity and receive the funds as a lump sum that you start paying right away. If you want the predictability of a fixed monthly payment, the home equity loan is a better choice than a HELOC.
- Cash-out refinance. To use a cash-out refinance as an alternative to a bridge loan, you would replace your current loan with a larger mortgage and use the difference for a new-home down payment.
THINGS TO KNOW
Keep in mind: If you’re considering a home equity loan, HELOC or cash-out refinance for extra cash funds, the home you’re financing can’t be listed for sale when the loan is disbursed.
80-10-10 piggyback loan. With this option, instead of taking out a home equity loan or HELOC on your current home, an 80-10-10 piggyback loan enables you to take out two loans on the new home — one for 80% of your home’s value and the other for 10% — and make a 10% down payment. When your current home sells, you can pay off the 10% second loan, and you’re left with only one mortgage payment (if you make enough profit from your current home sale).