When you’re moving from one home to another, it’s common to need the funds from the sale of your first house to use as a down payment on your new home. But what if you need to close on your new house before your current one has sold?
In that situation, a bridge loan could be a good solution. Let’s review how a bridge loan works and whether it’s right for you.
Key Takeaways:
- A bridge loan is a short-term loan you can use to bridge the gap between selling an existing home and buying a new one.
- Although a bridge loan might give you an edge in a competitive market, it can come with high costs and strict borrowing requirements.
- There are alternatives to bridge loans worth considering.
What Is A Bridge Loan?
A bridge loan is a short-term loan that provides temporary funding when you don’t have the money to make a large purchase. In real estate, borrowers typically use bridge loans to close the funding gap between buying and selling a home.
The ideal scenario for most home sellers is to sell their house and use the money from the sale to buy their next home. But real estate transactions don’t always follow that script. That’s where a bridge loan can help.
You may need a bridge loan if you need to move quickly before selling your current house, such as when relocating for a job. Or, you may need a bridge loan if you’ve truly found your dream home and don’t want to risk losing it while waiting for your current house to sell.
How Does A Bridge Loan Work?
Bridge loans typically last 3 months to 1 year. Lenders typically package these short-term loans in one of two ways to meet a borrower’s needs:
- Holding two loans: You use the equity in your current home to take out a bridge loan. The funds from the bridge loan, or second mortgage, are applied to the down payment for your new home while you keep your mortgage on your current home. When you sell your home, you’ll use the sale proceeds to pay off the bridge loan and the existing mortgage.
- Rolling both mortgages into one: You take out one large loan, pay off the balance of your first mortgage, and then apply the remaining funds toward the down payment on your next home.
Home buyers often turn to bridge loans to be able to submit a contingency-free offer on a new home. It allows them to say they can buy a house without needing to sell their existing home.
A contingency-free offer is attractive in a seller’s market, where multiple buyers are likely bidding on homes. A seller will likely choose an offer without a home sale contingency because it means the buyer doesn’t need to sell their current house before the transaction can close.
With a bridge loan, you can potentially make a 20% down payment and avoid private mortgage insurance (PMI). You pay PMI when you make less than a 20% down payment on a conventional mortgage or when you do not start out with at least 20% equity in your home, which increases your monthly payments. You may have built-in equity in your home if it appraises much higher than your mortgage amount.
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How To Get A Bridge Loan
Bridge loans often have a faster application, approval and funding process than traditional home loans. To get a bridge loan:
- Find a lender. Check with your local credit union and banks before exploring other options, such as nonqualified mortgage lenders or hard money lenders.
- Check the lender’s eligibility criteria. Every lender is different. Be prepared to provide the necessary documentation to prove your income and assets.
- Apply and complete the underwriting process. Some lenders allow borrowers to complete the application online; others require borrowers to complete it by hand.
- Close on the loan. Before signing on the dotted line, review the loan’s terms carefully, including the interest rate, repayment schedule and loan fees.
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Qualifying For A Bridge Loan
When you need a bridge loan, your debt-to-income ratio (DTI), loan-to-value ratio (LTV), credit history and FICOⓇ score all matter. You may need a higher credit score than with a conventional mortgage because you’re either taking out a second loan or borrowing a larger amount.
Some lenders may require a credit score as high as 740 to get a bridge loan, as well as a DTI below 50%. However, these requirements vary by lender.
You’ll also need a lot of equity in your current home to qualify. Most bridge loan lenders will generally allow you to borrow up to 80% of your home’s loan to value ratio, so you’ll typically need at least 20% equity in your current home.
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Pros and Cons of Bridge Loans
If you’re thinking of getting a bridge loan, it’s important to understand the benefits as well as the drawbacks.
| Pros: | Cons: |
|---|---|
| You can close on a new home without having to sell your current one first. | You may be looking at a higher interest rate than with a conventional mortgage. |
| You can present yourself as a stronger buyer without a sale contingency. | You generally need at least 20% equity in your current home to qualify. |
| You may be able to avoid PMI. | You may have to meet more stringent credit score requirements. |
| You may be able to move from one home to another with less stress. | You could end up in a bind if your current home takes longer to sell than expected, or doesn’t sell at all. |
Bridge Loans Alternatives
A bridge loan may be appropriate when you want to purchase a new home but still need to sell your existing one – but it’s not the only solution. Here are some potential alternatives.
Home Equity Line Of Credit (HELOC)
A home equity line of credit, or HELOC, allows you to borrow money against the equity in your home. You can borrow from the line of credit up to a certain limit, and you’ll often pay interest only on the amount you use during the HELOC’s draw period.
While a HELOC may offer a lower interest rate than a bridge loan, it may not be an option once your house is on the market. Some lenders won’t approve a HELOC on a house that’s for sale because it’s considered a less secure investment.
Home Equity Loan
With a home equity loan, you borrow against the equity in your current home, using the home as collateral for the loan. The home equity loan term can last 10 – 30 years, depending on your lender, and often offers a lower interest rate than a bridge loan. However, you’ll have two loans to pay off if you take out a home equity loan.
Personal Loan
You may qualify for a personal loan with a solid credit history of on-time payments and a credit score that meets your lender’s required minimum. Personal loans are typically unsecured, which means they don’t require collateral, and their terms and conditions vary by lender. As with a home equity loan, though, you’ll have two loans to pay off.
Piggyback Mortgage
Also known as an 80-10-10 loan, a piggyback loan is a way to buy a new home without putting 20% down (and avoiding PMI).
With a piggyback mortgage, you put down 10% of a home’s purchase price and secure two mortgages: one for 80% of the new home’s price and the second for the remaining 10% of its purchase price.
After selling your current home, you can use the proceeds to pay off the outstanding balance on your existing mortgage. And there may also be enough money to cover the smaller 10% mortgage on the new property, leaving you with just the larger mortgage covering 80% of its purchase price.
However, as with a bridge loan, you may incur higher costs. That’s because you’re paying closing costs on two separate loans. Also, you may end up with a higher interest rate on your second mortgage than what you’d qualify for on a primary mortgage. You’ll need to run the numbers to see if those costs are more than what PMI would cost you.
Here’s how a mortgage like this might work. If you’re buying a $400,000 home, you might make a 10% down payment of $40,000, take out a first mortgage of 80% of the home’s price, or $320,000, and then take out a second mortgage (like a home equity loan or HELOC) for the remaining 10% of the home’s price, or $40,000. Structuring your financing into two loans helps you avoid PMI by keeping the primary mortgage at or below 80% of the home’s purchase price.
FAQ
The decision to take out a bridge loan is a big one. Here are some commonly asked questions that you should review first.
The Bottom Line on Bridge Loans
Though a bridge loan can be a good solution when you’re buying a home before selling your current one, whether it’s right for you will depend on your financial situation. If you’re thinking of getting a bridge loan, weigh the pros and cons carefully, and make sure you fully understand the terms of the loan you’re signing before moving forward.
Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
