When you’re trying to finance real estate purchases, timing is crucial. A real estate “bridge loan,” or bridge mortgage, is a short-term mortgage financing option for those who need immediate funds to purchase a new property before selling their current one.
How a bridge loan works
Let’s say you have 15-20% equity in your current home. Using your home as collateral, you can use that equity to get a bridge loan to complete an upcoming real estate transaction. The bridge loan gives you enough funds to pay the additional costs of the new home, including a higher price, and not lose that buying opportunity because you don’t have enough cash to complete the transaction. You then repay that short-term loan when you sell your current home.
This loan bridges the financial gap between selling your existing home and purchasing a new one. It also can offer a financial cushion if you sell your current home before you buy a new one and must fund temporary housing. But how does a bridge loan work? Let’s explore its mechanics and real-life applications.
When to use a bridge loan
Homebuyers often use a bridge loan or “swing loan” to act quickly in a competitive real estate market. For instance, if you’ve found your dream home but have yet to sell your current one, a bridge loan can provide the necessary funds to proceed.
It’s also useful for buyers participating in an auction or facing a time-sensitive purchase. However, it’s important to consider the financial implications since bridge loans typically have higher interest rates and fees than traditional mortgages.1,2
Here are some situations in which you should consider using a bridge loan.
1. When you’re relocating for work
If you need to relocate for work, a bridge loan can help you purchase a new home while waiting for your current one to sell. This scenario is common among professionals who need to relocate for career advancement but don’t want to rush the sale of their existing property.
2. When the seller won’t accept your buyer’s contingency
Often, sellers won’t accept your offer contingent on you selling your current home.³ Getting a swing loan can help you bridge any cash gap so you can make an offer while you wait for your current home to sell. That’s particularly important in a competitive market where you’re competing with multiple bidders.
3. Your closing date on your new home comes before you sell your current home
In some home-buying transactions, the dates when you need to close on your new home purchase and your current home sale do not line up. Perhaps the home you want to buy becomes available before you can sell your current house.
In these and other scenarios, a bridge mortgage makes the logistics of buying one home before the other sells possible. Real estate bridge loans allow you to move forward with your new home plans without waiting for your old house to sell, which could take months.
Requirements to get a bridge loan
You need to meet specific criteria to secure a bridge loan. Because these types of loans increase your current debts and mortgages, lenders typically look for:
- A credit score of 700, although some lenders may go lower.
- A debt-to-income (DTI) ratio below 50%.³
- At least 15-20% equity in your current home.³
- Additional financial qualifications, such as proof of income and assets.
These requirements ensure borrowers have the financial stability to manage the additional loan burden.
Bridge loan alternatives
While bridge loans offer a quick solution, they’re not your only option. Some loan options may be better for you financially. Consider these alternatives:
A Home Equity Line of Credit (HELOC) allows you to borrow against your home’s equity, even if you have bad credit. It’s a flexible option, often with lower interest rates than bridge loans. HELOCs provide a revolving credit line, making them suitable for ongoing expenses or as a safety net during the home-selling process.
Taking a HELOC instead of a bridge loan can result in financial issues if you’re unprepared for its balloon payment. That’s a large final payment due at the end of the loan if the full amount of the loan isn’t repaid by then. People often experience “HELOC shock” because they’re surprised by an unexpected balloon payment.
Before getting a HELOC, carefully review the loan paperwork to learn the balloon amount you’ll be expected to pay. Create a payment plan or plan to refinance your HELOC into a traditional loan before the HELOC term ends to avoid balloon payment surprises or money problems, including potential foreclosure, later.
2. Cash-out refinance
This involves refinancing your current mortgage and taking out the difference in cash, which you then use for your new property purchase. It’s a viable option for those with significant equity in their home and can offer lower interest rates compared to real estate bridge loans.
3. Personal loan
Unsecured personal loans can be used for any purpose, including real estate transactions, though they might come with higher interest rates. They are a good option for borrowers with strong credit profiles who need smaller amounts of funding.
4. 80-10-10 Loan
Also known as a “piggyback loan,” this involves taking out a mortgage for 80% of the home’s value, a second mortgage for 10%, and paying the remaining 10% as a down payment. Because you’ve put a 20% down payment on your home when you take out this mortgage, an 80-10-10 loan helps you avoid paying private mortgage insurance, or PMI. That’s insurance you’d have to buy if you don’t put at least 20% down on your home. PMI protects the lender if you default on or don’t pay your mortgage. It’s usually included in your monthly mortgage payment. An 80-10-10 loan can be a cost-effective alternative to bridge loans.
5. Home Equity Loans
Like a HELOC, a home equity loan provides a lump sum based on your home’s equity but with a fixed interest rate. It’s suitable for those who need a specific amount of money upfront and prefer the stability of fixed payments.
Bridge loans: Pros and cons
Bridge loans have advantages and drawbacks. You should consider all the pros and cons carefully before deciding if a bridge loan makes sense to finance a real estate transaction.
- Avoid contingencies: In a seller’s market, bridge loans provide the quick financing needed to secure a property. This can be crucial in avoiding missed opportunities in fast-moving real estate markets, especially with sellers who won’t accept buyer contingencies. An example is your offer being contingent on you selling your current house first before you can buy theirs.
- Flexibility. Bridge loans provide flexibility when you’re house hunting. For example, you can wait until you sell your house to repay or make interest-only payments.
- Speed: Bridge loans offer rapid access to cash, often within a few weeks, making them ideal for time-sensitive purchases.
- Higher costs: Bridge loans often come with higher interest rates and high origination fees, making them more expensive over the short term compared to traditional loans.¹
- Double payments: When you get a bridge loan, you’ll have to make two payments simultaneously – the mortgage and bridge loan payment. This can be a significant financial burden, especially if your current home doesn’t sell quickly.
- Qualification challenges: Stringent financial requirements, like a higher credit score and home equity requirements, can make bridge loans hard to obtain. That’s especially true for those with less-than-ideal financial profiles.
- Quick payoff expected: The repayment terms for bridge loans are often only 6 to 12 months.³ That may be challenging if you don’t sell your home quickly enough or have other financial challenges.
- Limited legal protections. Unlike traditional loans, you won’t have the same consumer protections with bridge mortgages.⁴ That makes it important to shop for the loans with the most protective terms possible.
Bridge loans vs. other loans: Differences explained
Bridge loans differ from traditional loans in several ways. Here are the main differences:
|Approval and funding speed: They are usually faster to obtain, often within a few weeks, which is beneficial in urgent real estate scenarios.
|Longer approval process: Traditional loans often have a more extended approval period, which can be a drawback in time-sensitive real estate deals.⁵
|Shorter terms: Typically, they have terms of up to one year, aligning with the short-term nature of most real estate transactions.
|Longer terms: They usually have terms of 15 to 30 years, providing a longer repayment period but also a longer commitment.⁵
|Higher interest rates: Reflecting their risk and short-term nature, bridge mortgages often have higher interest rates compared to long-term mortgage loans.
|Varied interest rates: Depending on the loan type and borrower’s credit, traditional loans can offer more competitive interest rates, especially for long-term financing.⁵
Strategically use a bridge loan to meet your real estate needs
Bridge loans provide swift but temporary financial support when purchasing a new property and selling your current home. These loans are particularly advantageous in fast-paced markets.
But understand these loans come with higher costs and strict qualification criteria. When you use them wisely, bridge mortgages can help you seamlessly transition between homes without renting first.
Weigh the pros and cons to determine if a real estate bridge loan aligns with your specific goals. Read more on how to get a mortgage.