Bridge Loan: All You Need to Know
At a Glance
If you need short-term financing for a down payment on a new home while you wait for your current home to sell, or if you want to make an offer without it being conditional on your home selling first, a bridge loan can come in handy. These short-term ‘gap’ loans can be helpful when you need quick cash flow during a real estate transaction. However, as with any form of financing, bridge loans have pros and cons. Read on to learn more.
In this article, you’ll learn:
What is a bridge loan?
A bridge loan, also called a “swing loan” or “gap loan,” is a loan designed to provide financing during a transitional period, such as between selling your current home and buying a new one. This short-term mortgage is secured by a portion of the equity in your current home (even if it’s for sale) and used toward the down payment as a new home.
Home equity is the difference between your home’s value and the balance of your mortgage.
Essentially, bridge loans help with the balance of buying and selling a house at the same time, allowing you to put a down payment on a new home before you can sell your existing home. It can help with the expense of managing the mortgages of two properties at the same time and is often relied on when flipping properties.
How do bridge loans work?
Because these loans are typically only used in specific situations, the structure, cost, and conditions of bridge loans can vary widely. For example, a bridge loan may use both homes as collateral, or it may involve cashing out equity from your current home and using that as a down payment for a new property. Some have monthly or interest-only payments while others require upfront or end-of-term lump-sum interest payments.
However, there are a few common characteristics:
- Terms typically range from 6- or 12-months.
- Loans are secured by the borrower’s home.
- The borrower must usually agree to finance the new mortgage through the same financial institution.
- Loan amounts can range from several hundred thousand dollars to over $1 million.
With bridge loans rates can vary, anywhere from the prime rate to the prime rate plus two percentage points.
1. Application process
The application process for a bridge loan is about the same as a regular mortgage, but there are a few differences to note:
- Check your home equity. You’ll need at least 15-20% equity to get a bridge loan, and you’ll need even more than that if you need extra cash for a down payment for a new home.
- Know your debt-to-income ratio. You’ll need to qualify with both the payments in your current home and the home you’re buying. If you have varying or unstable income, paying several mortgage payments can quickly drain your savings.
- Improve your credit. While you’ll find bridge loan lenders that accept lower credit scores from borrowers, a high score will get you a lower rate.
- Compare lenders. Bridge loans are a specialized product so not all lenders offer them. Talk to local banks and credit unions, non-qualified mortgage (non-QM) lenders who specialize in alternative loan products, and hard-money lenders who offer loans with short repayment terms. Make sure the lender is reputable before working with one.
Once you find a lender, you’ll apply. Note that you will qualify for a bridge loan based on your:
- Credit score
- Income
- Assets
- Appraisal of your current home (to confirm its value)
Also, know that closing costs and fees can be expensive, so confirm how much you’ll owe to your lender ahead of time.
2. Requirements
Credit score
Bridge loan lenders have more underwriting flexibility than mortgage lenders, so you may be able to get a bridge loan with a credit score as low as 500. However, most lenders require scores in the high 600s to qualify.
DTI ratio
Experts recommend keeping your debt-to-income (DTI) ratio, which is all your monthly debt payments divided by your gross monthly income, below 36%. However, due to more underwriting flexibility, some lenders allow a DTI ratio as high as 50%.
Equity
You’ll need at least some equity in your current home to take out a bridge loan. Many lenders require at least 15%, while others may require 20%.
3. Example
For example, say you need a bridge loan of $100,000. Your current home is worth $250,000 and you have a $75,000 balance left on your mortgage. Of that $100,000, $75,000 would go toward the mortgage, and another $3,000 would go toward closing costs. With the bridge loan, you now have $22,000 for your next purchase (as long as the sale of your current home goes through).
Another example is that you buy a home for $350,000. Your current home is worth $300,000. You owe $100,000 on your current mortgage. The bridge loan company lends you 75% of your home’s value as a new first mortgage that replaces your current mortgage to give you cash back. Or, they may offer you the loan as a second mortgage that’s added to your first one, and you’ll get cash back.
In this case, the bridge loan would be $225,000. After paying the $100,000 you currently owe, you’d get $125,000 cash back for your new purchase. That $125,000 is converted home equity that you can use while you wait for your current home to sell.
Pros and cons of a bridge loan
Pros
- Can help cover the financing gap between selling an old home and buying a new one.
- Loan amount up to $1 million or more.
- Closing on a bridge loan can happen as fast as two weeks.
- Can defer payments until the current home sells, or make interest-only payments.
- No contingency is needed on your new home purchase.
- May be able to make a larger down payment on the home you’re buying.
Cons
- Typically do not offer protections for the loan holder (For example, if the borrower has trouble selling the current home or the loan extensions expire, the lender can foreclose on the property.)
- Short-term (ranging up to 12 months).
- Closing costs and fees.
- Must have 15-20% equity in the current home.
- May have to use the same lender for a bridge loan and a new home mortgage.
- Typically have higher interest rates and APRs.
Why take out a bridge loan?
You may need a bridge loan for a few reasons, such as if you are buying:
- A new home in a highly competitive market: When a home has multiple offers, a seller is less likely to accept an offer that’s contingent on the sale of a home since it makes financing riskier. However, a bridge loan can help you get enough cash to bridge the gap between your current home and new home payment until your home sells.
- A fix-and-flip home: If you’re buying a home to fix up, flip, and re-sell, you may want to consider a bridge loan because the fast financing will allow you to get the property quickly. You can repay the loan when renovations are complete.
- A fixer-upper: If your new property needs significant repairs but they don’t meet traditional loan guidelines, a bridge loan may give you the money you need to complete the extra renovations without having to tap into savings.
Other reasons to consider a bridge loan include:
- If you found a new home but the seller won’t accept a contingency offer to sell your current home.
- Your closing date for your current home is after your settlement for your new one.
- You can’t come up with a down payment for a new purchase unless you sell your current home.
Alternatives to a bridge loan
1. Personal loan
If you have good to excellent credit, you may qualify for a personal loan. While you typically can’t use a personal loan toward a down payment on a home, you can use it to purchase your new home completely in certain situations. For example, if you’re buying a tiny home or a low-cost fixer-upper. You may also be able to pay off your current mortgage with a personal loan, though personal loans often have higher interest rates than mortgages so you’ll end up paying more over time.
Personal loans can also be used for debt consolidation, home renovations, and more. Rates depend on your creditworthiness, and loan amounts and terms depend on additional factors like your income and DTI ratio.
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