You and your spouse need a bigger place, so you plan on selling your one-bedroom condo and using that money to buy a two-bedroom townhouse. If you buy and sell simultaneously, you can use the profits from your current home for a down payment and renovation costs on your new one.
Sounds like a great idea, right?
There’s just one problem: one week before you close on your new home, your buyer backs out. You put your house back on the market, but there’s no way it’s going to sell in time, and you need your down payment and closing costs immediately.
That’s when a bridge loan comes in handy.
A bridge loan is a loan you can use to finance a new house or pay off existing debt, and help “bridge” the gap between when you need the money and what you have it.
In this post, I will explain:
Let’s get started with this post.
What Is A Bridge Loan?
A bridge loan helps serve as a funding source and capital until you can secure permanent financing, or pay off debt due before you have money for it. Like hard money loans, bridge loans are short-term, usually lasting only 6 - 12 months.
Bridge loans are commonly used in real estate transactions, especially in simultaneous buying and selling situations. Usually, you’d want to wait until your current property is under contract before you make an offer on a new home, but real estate is sometimes tricky. For example, what if you suddenly had to move across the country and need immediate funds until your home sells, or if you need to make a home purchase right away or risk losing it? A bridge loan can save the day.
In the real estate world, bridge loans have many other names. They’re also called:
How Does A Bridge Loan Work?
Primarily, bridge loans help home sellers when their simultaneous buy and sell doesn’t work out, or when they need to suddenly or unexpectedly move. They can cover your closing costs, help with a down payment, act as a second mortgage, and more. You can get a bridge loan through a lender, but you should do your research first.
Bridge loans lenders handle interest differently. Some lenders require you to pay interest along with your monthly payments. Other lenders require lump-sum interest payments, either paid upfront or at the end of your loan’s term.
While the terms and conditions of bridge loans can vary greatly, most of them share the following characteristics:
There are two main ways lenders can package bridge loans to meet your needs:
Hold Two Loans
If you hold two loans, you can borrow the difference between your loan’s current balance and up to 80% of your home’s value. The money available in your second mortgage is applied to your new home’s down payment. Meanwhile, you’re keeping your first mortgage intact until you sell your old home. Then, you pay it off.
Combine Both Mortgages
By rolling both mortgages into one, you can take out a single, large loan for up to 80% of your property’s value. This allows you to pay your first mortgage’s balance, then use the second towards your new home’s down payment.
When Do You Need A Bridge Loan?
Here are the most common situations when you may need a bridge loan:
Who Is Eligible For A Bridge Loan?
Taking out a bridge loan is a little different than the traditional mortgage loan process. Given their urgency, the application and approval process is faster than with a conventional mortgage. However, the qualifications differ. You’ll need many of the conventional mortgage basics, including:
You’ll also need a lot of equity in your current property. As a short-term loan, bridge loans can be hard to get and are often reserved for borrowers who excel in all the mentioned qualifications. It’s also common for your mortgage lenders to require you to take out a bridge loan with them.
As mentioned earlier, if you’re eligible for a bridge loan, you can borrow up to 80% of your current home’s equity.
How Much Does A Bridge Loan Cost?
Bridge loans aren’t cheap. You should expect to pay 2% - 5% of the amount you borrow in closing costs, up to 2% of your loan’s original value, and additional fees. Also, all this is before you close on your home’s new mortgage.
Let’s say your loan is $300,000 at a 4% interest rate for 30 years. With a conventional loan, you’d pay $1,432/mo. If your bridge loan adds 2%, your monthly payment jumps up to $1,799. That’s a $367 difference!
If you’re required to pay 3% of closing costs on the loan, that’s an additional $9,000!
How Do You Repay A Bridge Loan?
money from the sale of your old home. However, bridge loans are structured in many different ways, and it largely depends on the type of loan you get.
There are four different kinds of bridge loans, the right loan depends on what you need:
Open Bridge Loan
Open bridge loans are great if you’re not sure when you’ll secure financing. For example, if you use a bridge loan to buy a new house when it’s not a seller’s market, and you’re not sure when your current first home will sell, you don’t know how long you’ll need short-term financing.
This type of bridge loan doesn’t have a specific payoff date, which can take some pressure off you if you’re struggling to sell. However, because of this uncertainty, you’ll have to pay high interest rates for this loan.
Closed Bridge Loan
Closed bridge loans are the opposite of open bridging loans. You and your bridge loan lender agree on a predetermined time frame to repay the loan. Most lenders prefer closed bridge loans, and you’ll pay a lower interest rate for them. The downside is that you need to come up with the money required to repay the loan within that time frame.
First Charge Bridge Loan
First charge bridge loans guarantee your lender gets their money before other lenders in the event of a default. Since there’s less risk, this loan type attracts a lower interest rate.
Second Charge Bridge Loan
If there’s a default, a second charge loan lender only begins to recoup their money after the first charge loan lender gets paid for all their accrued liabilities. Since this means the second bridge loan lender is taking a bigger risk, they’re going to charge higher interest rates.
The Pros And Cons Of Getting A Bridge Loan
There are multiple benefits and setbacks to getting a bridge loan. Whether they’re worth getting depends on your situation. Here are both the main pros and cons of bridge loans.
Bridge Loan Alternatives
If you’re stuck in one of the scenarios I’ve mentioned, bridge loans aren’t your only option. There are several loan alternatives you should also look into.
Home Equity Loans
A home equity loan lets you borrow against the equity you currently hold in your home, using your property as collateral. Unlike bridge loans, your home equity loans offer long-term financing (sometimes lasting up to 20 years), which usually lets you take one for a lower interest rate.
While a home equity loan can get you out of a sticky financial situation, they can also put you deeper in debt if you’re not careful. Getting a home equity loan will require you to pay two mortgages while you have one, or even three, if you buy a new house before selling yours.
Home Equity Line Of Credit (HELOC)
Home equity lines also act as a second mortgage, but offer lower closing costs, better interest rates, and longer repayment periods than bridge loans. HELOCs are typically used to renovate your home or make other upgrades, but they can also help you with other financial situations.
Again, be mindful that a HELOC acts as an additional mortgage. Some of them can also come with prepayment fees, which charge you money if you pay your loan off early.
Business Line Of Credit
A business line of credit is sort of like the business equivalent of a HELOC. Business lines of credit have repayment periods of up to 10 years, but they tend to have higher interest rates and are harder to get than bridge loans.
An 80-10-10 loan lets you purchase a new home by putting 10% down and obtaining two mortgages: one for 80% of your new home’s asking price, and a second for the last 10% of the purchase price. When you sell your current home, you can use the additional funds to pay off the second 10% of your new house and any other outstanding balances.
An 80-10-10 loan lets you avoid private mortgage insurance (PMI) and additional fees you’d otherwise have to pay if you don't put at least 20% down. While you’ll have three mortgages before selling your old house, you’ll be down to just one monthly mortgage payment.
A personal loan is a flexible loan that you can take out to accomplish a goal, whether you’re consolidating high interest debt, starting a new business, or need immediate cash flow to finance buying a new home. To get a personal loan, you need good credit and a low DTI ratio. Depending on the terms, you may be able to get a better interest rate with a personal loan than with a bridge loan.
Conclusion: Should You Get A Bridge Loan?
While bridge loans can be expensive, they can help when you’re in a pinch. I would recommend trying to sell your current home before buying a new one, or getting the seller to agree to a contingency. You could end up in a risky situation if they don’t.
If you have to immediately relocate or need to secure funding on a home right away, bridge loans are helpful if you know you can repay them.
I recommend weighing all your options (in this case, examining bridge loan alternates) before finalizing any loan contract. Also, you should understand that you’ll be dealing with a lot of debt and could pay multiple mortgages until you sell your home. In short, if taking out a bridge loan is your best option, have a plan and a backup plan to pay it back.