What Is a Bridge Loan?

Written by Elijah BishopUpdated: 15th Mar 2022
Share this article

Disclaimer: This post contains references to products from one or more of our advertisers. We may receive compensation (at no cost to you) when you click on links to those products. Read our Disclaimer Policy for more information.

If you’re moving into a new house, a bridge loan is a good way to have some additional cash on hand to help with the move. Typically, bridge loans tackle the financing difficulty when a home buyer seeks to purchase a new property before their current home sells.

Here’s all you need to know about getting a bridge loan, how it works, and whether it is the right loan for you.

What Is a Bridge Loan? 

A bridge loan is a type of short-term financing that allows people and businesses to borrow money for up to a year. Bridge loans are also known as bridging loans, interim loans, gap loans, or swing loans, are secured by collateral such as the borrower’s home or other assets.

On the other hand, bridge loans have a faster application and underwriting process than standard loans. Plus, if you can get a mortgage to buy a new home, you should be able to get a bridge loan as well—assuming you have enough equity in your current property. As a result, bridge loans are a popular choice for homeowners who need immediate cash to buy a new home before selling their present one.

>> More: Best Mortgage Lenders

How Does a Bridge Loan Work? 

Bridge loans are frequently employed by sellers who are in a bind or need to relocate quickly. Simultaneously, bridge loans’ terms, conditions, and costs vary substantially across particular transactions and lenders. 

In general, customers looking for a bridging loan have two options:

  • To use the bridge loan as a second mortgage to help pay for the down payment on their new house until they can sell their present one.
  • To take out a single large loan to pay off their old house’s mortgage and put the remainder of the borrowed funds toward the down payment on their new property.

Bridge loans, on the other hand, tend to:

  • Run for 6-month or 1-year periods.
  • Be secured by the borrower’s current home as collateral
  • Be issued only by lenders with whom you have agreed to finance your new mortgage.
  • Interest rates vary, with costs often sitting somewhat above the prime rate.

It is important to note that applying for a bridge loan is identical to applying for a regular mortgage. When reviewing applications, your loan officer will consider various variables, including your credit score, credit history, and debt-to-income ratio(DTI). 

Furthermore, most bridge loans lenders will allow applicants to borrow up to 80% of their loan-to-value ratio (LTV). In other words, to qualify for a bridge loan package, you’ll normally need a minimum of 20% equity in your present property, as well as meet extra financial conditions specified by the lender.

When Should You Use a Bridge Loan? 

Bridge loans are most typically employed when homeowners purchase a new home before selling their current one. Borrowers can utilize a portion of their bridge loan to pay down their current mortgage, while the remainder is used as a down payment on a new house. Similarly, a bridge loan can be used as a second mortgage to support the down payment on a new home.

If you meet the following criteria, a bridge loan may be a good option for you:

  • Have decided on a new home and live in a seller’s market where houses move rapidly
  • You want to buy a house, but the seller will not accept an offer conditioned on the sale of your current home.
  • You can’t afford a down payment on a new home until you first sell your present one.
  • Want to buy a new house before selling your old one

Businesses can also use bridge loans to capitalize on quick real estate opportunities or pay short-term needs. These loans are often available to businesses and mortgage investors through hard money lenders, who fund loans using your property as collateral, and online alternative lenders.

Bridge Loan Costs 

If you wish to buy a new house or other real estate but haven’t sold your current property, bridge loans are a practical way to secure temporary financing. However, this financing is often more expensive than a regular mortgage. 

Bridge loan interest rates vary depending on your creditworthiness and loan amount, but they typically range from the prime rate—currently 3.25 percent —to 8.5 percent or 10.5 percent. Interest rates for company bridge loans are much higher, ranging from 15% to 24%.

Borrowers must pay closing costs, as well as additional legal and administrative fees, in addition to the interest on the bridge loan. A bridge loan’s closing expenses and fees normally vary from 1.5 percent to 3 percent of the entire loan amount.

Different Types of Bridge Loans 

Bridge loans are classified into four types: open bridging loans, closed bridging loans, the first charge bridging loans, and the second charge bridging loans.

Closed bridge loans

A closed bridging loan is accessible for a set period (often a few months) agreed upon by the lender and borrower. Closed bridging loans are more accessible since the lender is more certain about loan repayment.

Open bridge loans

There is no set repayment date for open bridge loans. As a result, they might be a tempting alternative for those who are unsure when they will be able to get the funds required to pay off the loan. Because of the increased uncertainty surrounding repayment, interest rates tend to be higher.

First charge bridging loans

A first charge bridging loans are employed when the property/asset being used as collateral has no further encumbrances; for example, the borrower may wholly own it because the mortgage is paid off. If the bridging loan is not paid back on time, the lender may sell the property.

Second charge bridging loans

A second charge Bridging loans are typically employed by those who need the money yet have a mortgage on the property used as collateral. In other words, the item already has a “first charge” on it.

How Do You Repay a Bridge Loan? 

Bridge loans are typically repaid in 12 months or less. Most people repay their bridge loan with the proceeds from their present house, but other choices exist. Bridge loans can be structured in various ways, but the most frequent is a balloon payment at the end with the full amount due by a specific date.

You may be allowed to postpone making monthly payments for a few months after the bridge loan closes, but this will depend on the specific loan you have been authorized for.

Pros and Cons of Bridge Loans 

Pros:

  • A bridge loan allows you to purchase a new property before selling your current one.
  • You can make an offer on a new house without putting a sale contingency in place.
  • It gives additional finances in an unexpected or time-sensitive change.
  • It provides a useful short-term answer for financing your way through uncertain times.
  • There is frequently the possibility of making no monthly payments for the first several months.
  • There is the possibility of interest-only payments or payments deferred till you sell.

Cons:

  • Bridge loans include higher interest rates and annual percentage rates (APR).
  • Before extending a bridge loan offer, most lenders demand at least 20% equity in their house.
  • Many financial institutions will only provide you with a bridge loan if you use them to get a new mortgage.
  • You may own two homes for a while, and maintaining two mortgages simultaneously might be onerous.
  • In the worst-case scenario, trouble selling your home might lead to future problems or foreclosure.

Bridge Loan Alternatives 

Below are some of the top alternatives to bridge financing:

Home Equity Loans 

A home equity loanmay be an option if you know exactly how much you need to borrow to make a down payment on your new house. It offers a lump-sum payout secured by the equity in your current house. These loans are often longer-term, with repayment terms of up to 20 years, and have lower interest rates than a bridge loan.

>> More: Best Home Equity Loans

Home Equity Line of Credit

A home equity line of creditis similar to a home equity loan in that it relies on the equity in your current house, but it operates more like a credit card. The interest rate is only levied if you access the funds, and it may be lower than the interest rate on a bridge loan. However, if your present house is on the market, this may not be a possibility with your lender.  

>> More: Best HELOC Lenders

80-10-10 Loan 

Homebuyers with 80-10-10 loans can obtain a mortgage covering 80 percent of the purchase price and then piggyback on that mortgage with a second loan covering 10 percent of the purchase price. Under this financing method, a homebuyer needs to put down 10% of the purchase price, hence the 80-10-10 designation. The borrower can then use the proceeds from their first home to pay off the second mortgage.

How Do You Qualify for a Bridge Loan? 

To determine if you qualify for a bridge loan, lenders will consider the following factors:

  • Equity. You’ll need at least 20% equity in your house to qualify.
  • Affordability. Lenders will assess your ability to repay several loan payments. Until the house sells, you may be paying a bridging loan, as well as a mortgage on your new property and your present mortgage. You’ll need adequate income or financial reserves to cover the installments or to pay off the loan if necessary.
  • The real estate market. How quickly will you be able to sell your home? A bridge loan may not be a suitable choice if your home is in a slow-moving market. Furthermore, you may find yourself making three different mortgage payments for longer than you anticipated, putting a strain on your finances.
  • Creditworthiness. You must demonstrate that you have dealt with debt responsibly in the past.

Is a Bridge Loan a Bad Idea? 

Although bridge loans appear to be a good idea, they can have certain disadvantages. They aren’t suitable for everyone. Bridge loans are more expensive than other forms of loans: The first major disadvantage of a bridge loan is its cost. Most of the costs are incurred due to the exorbitant fees they demand. In addition, you may end up selling your property for less than you expected, which will leave you with a higher home loan balance than you initially planned.

>> More: Understanding Fair Market Value of a Home

What Is a Bridge Loan Example?

Let’s imagine your present home is worth $175,000, and you want to sell it. You owe $75,000 in debt. You want to put down a 20% down payment of $55,000 on a new home that costs $275,000.

You can borrow $135,000 with a first mortgage bridge loan. You pay off your mortgage, leaving you with enough money for a 20% down payment and $5,000 in closing costs. You borrow $60,000 via a second mortgage bridging loan. You put down a $5,000 deposit on your new home and still have $5,000 leftover for closing costs.

Bottom Line: Bridge Loans 

Bridge loans are a great option if you need to move quickly to purchase a property. Like any other home loan, it’s not a debt to be taken on lightly, and it pays to speak to a professional mortgage broker so they can provide the right recommendations to you.

Keep Reading:

Elijah Bishop
Elijah Bishop

Elijah A. Bishop is a Senior Personal Finance Writer who has been writing about real estate and mortgages for years. He has a Bachelors of Arts Degree in Creative writing from Georgia State University and has also attended the Climer School of Real Estate. He also holds a realtor license and has been in and out of the US mortgage industry as a loan officer. Bringing over 15 years of experience, Elijah produces content that analyzes ethnicities, race, and financial well-being. His areas of expertise are mortgages, real estate, and personal loans.