What Is A Bridge Loan?

What is a bridge loan?

A bridge loan is a short-term loan designed to provide financing during a transitionary period, such as moving from one house to another. Homeowners faced with sudden transitions, such as having to relocate for work, might prefer a bridge loan to the help with cost of buying a new home.

Like mortgages, home equity loans and HELOCs, bridge loans are secured by your current home as collateral. They aren’t a substitute for a mortgage, however. Each loan is short-term, designed to be repaid within six months to three years.

How does a bridge loan work?

A tool typically used by sellers in a bind, bridge loans vary widely in their terms, costs and conditions. Some are structured so they completely pay off the old home’s first mortgage at the bridge loan’s closing, while others pile the new debt on top of the old.

Borrowers also may encounter loans that deal differently with interest. Some carry monthly payments, while others require either upfront or end-of-the-term, lump-sum interest payments.

Most share a handful of general characteristics, though. They usually run for six-month terms and are secured by the borrower’s old home.  Lenders also rarely extend a bridge loan unless the borrower agrees to finance the new home’s mortgage with the same institution. As for rates, they accrue interest at anywhere from the prime rate to the prime rate plus 2 percent.

Bridge loans can be costly to obtain, too. Closing costs are usually a few thousand dollars, plus up to 2 percent of the loan’s original value, and they usually come with origination fees — and that’s before you even close on your new home mortgage.

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Say you obtain a bridge loan for $70,000, with your current home worth $100,000 and a $50,000 balance left on your mortgage. Of that $70,000, $50,000 would go toward the mortgage, and another $2,000 would go to closing costs. Thanks to the bridge loan, you’d now have $18,000 for your next purchase — if all goes well with the sale of your current home.

Even though most buyers get a bridge loan to cover finances between purchasing a new house and selling the old one, they rarely come with protections for the loan holder if the sale of the old home falls through. In such a case, the lender could go as far as to foreclose on the old property after the bridge loan extensions expired. Given this risk, it’s important to consider a bridge loan carefully based on what you can afford and how quickly homes are selling in your market.

Where can you find a bridge loan?

Many lenders offer bridge loans, but you’ll usually have to secure one through your current mortgage provider. Speak to your lender if you think your situation calls for a bridge loan.

Alternatives to a bridge loan

Home equity loans are one of the most popular alternatives to bridge loans. Like a bridge loan, they are secured loans using your current home as collateral, but that’s where the similarities end. Home equity loans borrow against available equity in your home. They are usually long-term loans, and repayment periods can be anywhere from five to 20 years. If you qualify, interest rates tend to be more favorable on home equity loans than on bridge loans.

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Using a home equity loan to finance part of a new home purchase, such as the down payment, can still be risky, however. If your original home fails to sell, you may find yourself paying three loans: your original mortgage, your new mortgage and the home equity loan. If you can, it’s still wise to wait until a deal closes on your original property. But, if you’ve built up sufficient equity in your current home, a home equity loan may be a solid alternative to bridge loans.

Bottom line

Getting a bridge loan may seem like a good idea if you buy a new home before you sell your old one, but it can be a risky proposition for your finances, and generally, you’re better off waiting to sell the old house first.

While they aren’t the best deal, a bridge loan might be necessary if you’re in a tight spot, such as relocating for work without much advance notice, trying to keep others from beating you to the punch on a property or needing help with the expensive upfront costs of buying a new home before your old one sells.

So, if you do decide to take out a bridge loan, be aware that you’re going to accrue a significant amount of new debt, and may wind up having to pay back multiple loans if your home doesn’t sell quickly.

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