What Is a Bridge Loan and How Does It Work?
Understanding Bridge Loans in Real Estate
A bridge loan is a short-term financing option often used in real estate transactions to provide cash flow during transitional periods. This type of loan is particularly useful for homeowners needing to finance a new home purchase or pay off debt while awaiting the sale of their current property. However, like any form of financing, bridge loans come with specific benefits and drawbacks.
While Rocket Mortgage® doesn’t currently offer bridge loans, understanding how they work can help you determine if this type of financing suits your needs.
Bridge Loan Definition
A bridge loan, also known as a swing loan, serves as a temporary source of funding until you can secure permanent financing or pay off existing debt. Typically, these loans are short-term, lasting from six months to a year, and are commonly used to purchase a new home before selling your existing one.
Most home sellers prefer to wait until their house is under contract before making an offer on a new property. This way, they can use the proceeds from the sale of their current home to help finance the new purchase. However, if selling your home quickly is not an option, bridge financing can provide the necessary funds to move forward with buying a new home.
How Does a Bridge Loan Work?
Bridge loans vary in terms, conditions, and fees from one lender to another. Some bridge loans are designed to pay off your first mortgage at closing, while others add new debt on top of the existing amount owed.
Key Features of Bridge Loans
Term Length: Typically six months to a year.
Collateral: Usually secured by the borrower’s current home.
Lender Requirement: Often issued by the same lender providing the new mortgage.
Interest Rates: Generally slightly above the prime rate.
Repayment: Can include monthly payments, interest-only payments, or lump-sum payments at the end of the term.
Types of Bridge Loans
Second Mortgage Bridge Loan: Used to cover the down payment on a new home until the current home is sold.
Single Large Loan: Used to pay off the mortgage on the old home, with remaining funds applied to the down payment on the new home.
When to Use a Bridge Loan
Here are some scenarios where a bridge loan might be beneficial:
You can't afford a down payment without selling your current home first.
You need to quickly secure a new home due to a career move.
Your new home’s closing date is before your current home’s sale closes.
You prefer to buy a new property before listing your current one.
Sellers in your desired area are not accepting contingent offers.
Bridge Loan Mortgage Requirements
Applying for a bridge loan is similar to applying for a conventional mortgage. Lenders will review your credit score, credit history, and debt-to-income (DTI) ratio. Some lenders may require a credit score of 740 or higher and a DTI below 50%, though requirements vary.
Most lenders allow you to borrow up to 80% of your loan-to-value (LTV) ratio, meaning you’ll typically need at least 20% equity in your current home to qualify. Additional financial qualifications may also apply depending on the lender.
Common Home Bridge Loan Mortgage Rates
Interest rates for bridge loans are typically about 2% above the prime rate and higher than conventional loan rates. Bridge loans also incur closing costs and origination fees, which can add up to several thousand dollars. An appraisal may also be required.
It’s important to note that protections for buyers are limited if the sale of their current home falls through. Since bridge loans are secured by your existing property, failure to make payments can result in foreclosure.
Pros and Cons of Bridge Loans
Pros
Allows you to buy a new house before selling your current one.
Eliminates the need for a sale contingency in your offer.
Provides funds for sudden or time-sensitive transitions.
Can offer interest-only or deferred payments until the sale of your current home.
Cons
Higher interest rates and APR.
Requires at least 20% equity in your current home.
Lenders may require you to obtain your new mortgage from them.
Managing two mortgages simultaneously can be stressful.
Trouble selling your property can lead to financial difficulties or foreclosure.
Tips on Shopping for a Bridge Loan
Bridge loans are available from various lenders, including banks, credit unions, and other financial institutions. It’s often best to start with your current mortgage provider.
Pro Tip: Be cautious of lenders offering quick access to capital, as they may charge excessive rates and have a poor track record of customer service.
Bridge Loan Alternatives
If a bridge loan isn’t the right fit, consider these alternatives:
Home Equity Loans: These loans allow you to borrow against the equity in your current home. They are typically long-term with comparable interest rates to bridge loans but require managing two mortgages if your current home doesn’t sell quickly.
Home Equity Line of Credit (HELOC): A HELOC acts as a second mortgage with better interest rates, lower closing costs, and more extended repayment terms than a bridge loan. Some HELOCs may have prepayment penalties.
80-10-10 Loan: This option involves making a 10% down payment and obtaining two mortgages: one for 80% and a second for 10% of the home’s price. After selling your current home, use the proceeds to pay off the 10% mortgage.
Personal Loan: If you have a strong credit history and low DTI, a personal loan could be an option. These loans can be unsecured or secured with personal assets.
The Bottom Line
A bridge loan can be a useful tool if you need to buy a new home before your current one sells. It can help you secure a new property in a competitive market or navigate a tight financial situation. However, bridge loans can be costly and add to your overall debt. The best strategy is to sell your old house before acquiring a new property, if possible.
