What is a Bridge Loan & How Does it Work?
Bridge loans are commonly used to buy a new home while waiting for a home you own to close. Businesses may use bridge loans while waiting on other funding. They can be difficult to qualify for but could help you get into a new home faster.
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A bridge loan is a type of short-term financing meant to provide the money you need until another source of funds becomes available. Homeowners often use bridge loans to build or buy a home before selling their current house.
There are risks to bridge loans, and not everyone can qualify for them—but they can be an important source of funding in some situations. This guide will help you to understand the pros and cons of bridge loans and when they might be necessary.
In this guide:
- Bridge loan definition
- Pros & cons of bridge loans
- When a bridge loan makes sense for buying a new home
- How to qualify for bridge financing
- Bridge loan alternatives
Bridge loan definition
Bridge loans are also called swing loans. They are loans meant to be paid off over a short period and, in some cases, they don’t require immediate payments.
They get their name because they help bridge the gap between the time you buy a new property and sell your current one.
How does bridge lending work?
When you want to buy a new home before selling your old home, you may not qualify for a mortgage on the new home because of your existing mortgage debt. Or you may not be able to come up with a down payment until you sell.
That’s where a bridge loan comes in.
Here’s how a bridge loan works: It provides funds you can use for a down payment and closing costs on the new home and even to pay off the existing mortgage on your first home. The bridge loan will have a short repayment term and is intended to be paid off when you sell your current home.
You’ll qualify for a bridge loan based on the value of your current home, which acts as collateral. You’ll usually have a choice between making interest-only payments or making no payments and instead paying off the bridge loan in a lump sum at the end of the loan term.
Note: Businesses sometimes also use bridge loans as a form of short-term financing when they need money to continue operating as they wait to qualify for a longer-term loan. This article will focus on bridge loans for home buying.
Pros & cons of bridge loans
- You can buy a new home before your current home sells.
- You may be able to go several months without making a payment: Many bridge loans give you time to sell your current home before a payment is due. This lets you avoid owing two mortgage payments.
- You can use a bridge loan to buy a new home without qualifying for a new mortgage: A bridge loan can provide the money to pay for a new home, so the sale won’t depend on your ability to get a mortgage (a condition called a financing contingency). Many sellers prefer offers without contingencies, so this could help you in a competitive real estate market.
- Bridge loans can be expensive: The origination fees for a bridge loan can be very high, and they tend to have high interest rates.
- You’re taking on a major risk: If your home doesn’t sell and you can’t repay the bridge loan, you risk foreclosure.
- Bridge loans can be difficult to qualify for: Not all lenders offer them, and they are usually available only if you have an excellent credit score and significant equity in your home.
When a bridge loan makes sense for buying a new home
A bridge loan may make sense if you need to get into a new home right away and cannot wait to sell your existing home. This might happen if:
- You are relocating for work and need to move right away, so you don’t have time for your existing house to sell before getting a new house.
- You don’t want to move into a temporary home after selling your current home—which could happen if you sell without having already purchased a new one.
- You want to make a non-contingent offer that doesn’t depend on you first securing a new mortgage loan on a new home—but you don’t have the cash do it.
Say you own a home valued at $150,000 with a remaining $75,000 mortgage balance. If you qualify for a bridge loan equal to 80% of your current home’s value, you could borrow a total loan amount of $120,000.
You could use that to pay off the current mortgage loan balance and put the remaining $45,000 toward your new home’s down payment and closing costs. You could move into the new home before selling your old one. When you do sell, you’d pay off the $150,000 bridge loan in full.
Unfortunately, there’s a risk that your current house won’t sell—in which case you’d be responsible for repaying the bridge loan as well as the home loan on your new house.
How to qualify for bridge financing
Bridge loan requirements vary by lender. In general, however:
- You must currently own a home.
- You typically can borrow up to 80% of the loan-to-value ratio (LTV) on your current home.
- Many lenders only offer bridge loans to customers who also take out the new mortgage with that lender.
- You’ll need to provide proof of income to show you can afford to pay your new home mortgage. Some lenders include the cost of the bridge loan in determining your debt-to-income ratio, but others exclude it.
Qualifying for a bridge loan can be difficult, and you typically need excellent credit. Check with local lenders as well as online mortgage lenders and marketplaces to see if you qualify.
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Bridge loan alternatives
Because bridge loans are expensive and difficult to qualify for, they aren’t the right choice for everyone. Consider these other financial products if bridge loans aren’t a fit for you:
- Home equity loans: A home equity loan lets you borrow against what you’ve already paid off on your current home. These loans can be cheaper and easier to qualify for, but you may not qualify if your home is on the market. You’ll usually need to make immediate monthly payments, unlike with a bridge loan.
- Home equity line of credit (HELOC): A HELOC gives you access to a credit line instead of a loan. The credit line is secured by your home’s equity. While a more flexible option than a home equity loan, your line of credit may not be large enough to cover costs to get into your new home.
- A cash-out refinance loan: This lets you take out a new mortgage that’s larger than your existing mortgage so you essentially convert your home’s equity to cash. The downside is the mortgage payment on the refinance loan will count in your debt-to-income ratio when you apply for a mortgage to buy the new home.
>> Read more: LendEDU’s Best Mortgage Lenders of the Year
Author: Christy Rakoczy