Bridge Loans: Everything You Need To Know
If you’re moving into a new home, a bridge loan is a way to have some extra cash on hand to ease the transition.
In short, bridge loans solve the financing problem that arises when a home buyer wishes to buy a new home before their current home sells.
Let’s consider a more detailed bridge loan definition and how this type of loan might work for your situation.
What Is A Bridge Loan?
A bridge loan is a form of short-term financing that can meet immediate cash flow needs at a time when you’re anticipating and needing an influx of cash, but the funds aren’t yet available. While this short-term loan is commonly used in business while waiting for long-term financing, individuals typically only use bridge loans in real estate transactions.
Specifically, a bridge loan can eliminate a cash crunch and “bridge the gap” while buying and selling a home simultaneously.
The best situation for a home seller is to have their house under contract and then use money from the sale of that property to buy their next home. Circumstances aren’t always perfect, however, and that’s where bridge loans come in.
In some cases, bridge loans can also help in a situation where you need a new home quickly. Job transfers are a good example of this scenario.
How Does A Bridge Loan Work?
Bridge loans typically have a term of 6 months or 1 year. Lenders package these temporary loans in one of two main ways to meet a borrower’s needs:
- Holding two loans: In this case, you borrow the difference between your current loan balance and up to 80% of your home’s value. The funds in this second mortgage are applied to the down payment for your second home while you keep your first mortgage intact until you’re ready to pay it all off when you sell your home.
- Rolling both mortgages into one: This solution allows you to take out one large loan for up to 80% of your home’s value. You pay off the balance of your first mortgage and then apply the second toward the down payment of your next home.
Home buyers most often turn to a bridge loan because it allows them to put in a contingency-free offer on a new home, meaning they’re saying they can buy the house without selling their existing home.
This can be an important factor in a seller’s market, where a number of buyers might be bidding on a home for sale. A seller is more apt to choose an offer without a contingency because it means they aren’t depending on the buyer’s current house selling before the transaction can close.
A bridge loan can also allow you to make a 20% down payment, which can help you avoid private mortgage insurance (PMI). This insurance is required if you don’t put at least 20% down on a conventional mortgage, and it essentially means a larger monthly payment on your mortgage. As a result, some homeowners use a bridge loan to avoid paying PMI.
The Cost Of Bridge Loans: Average Fees And Bridge Loan Rates
A bridge loan mortgage can be a handy option to get you out of a jam, but you’ll pay for the convenience. More specifically, a bridge loan has a higher interest rate than a conventional loan. While interest rates vary, let’s look at the implications of a bridge loan with an interest rate 2% higher than on a standard, fixed-rate mortgage.
On a $250,000 conventional loan with a 3% interest rate, you might be paying $1,054 – an amount that would rise to $1,342 with a bridge loan that had a 2% higher interest rate.
Bridge loans have a higher interest rate because the lender knows you’ll only have the loan for a short time. That means they aren’t able to make money servicing the loan over the long-term.
Some other fees you should be aware of with bridge loans:
- Closing costs and related fees: Bridge loans require closing costs and fees, much like you’d pay with a traditional mortgage. These fees may include administration fees, appraisal fees, escrow, a title policy, notary services and potentially other line items that your lender will explain.
- Origination fees: Finally, you’ll pay a loan origination fee based on the amount you’re borrowing. With each point of the origination fee (which your lender will arrive at based on the type of loan you take out), you’ll typically pay about 1% of the total loan amount.
While these fees don’t seem enormous, remember that you can only keep your mortgage bridge loan for up to 1 year – which means you’re likely to be paying those fees again when you get the new mortgage that will replace the one you pay off when your old home sells. These fees are essentially money out of your pocket that you won’t recoup.
How Much Can You Borrow On A Bridge Loan?
While terms vary from lender to lender, a bridge loan typically allows you to borrow up to 80% of the combined total value of your current home and the home you’re looking to purchase.
Alternatives To Bridge Loans
A bridge loan can appear to be a good solution if you’re in a situation where you want to buy a new home but still have an obligation on the home you still own and need to sell. If you determine a bridge loan isn’t for you, however, here are some potential alternatives.
Home Equity Line Of Credit (HELOC)
A home equity line of credit, also known as a HELOC, allows you to borrow money against the equity in your home. A HELOC is a little like a credit card in that you might be approved for a certain amount but you’re only paying interest on the amount you use at any given time.
While you may qualify for a lower interest rate than you would with a bridge loan, a HELOC may not be available to you once you put your house on the market. That’s because some lenders won’t grant a HELOC to someone whose house is currently for sale. If available, a HELOC can be used to make home improvements.
Home Equity Loan
With this form of financing, you use your current home as collateral, which allows you to borrow against your current home equity. A home equity loan is typically long-term, potentially having a term of up to 20 years, and often comes with a better interest rate than a bridge loan. You still might need to carry two mortgages with this type of loan, though.
If you have a solid credit history and a strong track record of employment and on-time payments, you may be able to get a personal loan. These loans are typically unsecured, which means they don’t require collateral, and their terms and conditions will vary by lender.
Our friends at Rocket LoansSM can help you get started with a personal loan if you choose to go this route.
Also known as a piggyback loan, an 80-10-10 loan is a way to buy a new home without putting 20% down while also avoiding PMI.
With an 80-10-10 loan, you pay 10% down and secure two mortgages: one for 80% of the new home’s price, and a second for the remainder. After selling your current home, you can use any funds left over after paying the outstanding mortgage balance to pay the smaller 10% mortgage on the new property.
Bridge Loan FAQs
Bridge loans are a complex financial product, so it’s possible you may still have questions. Of course, so much depends on the borrower’s individual circumstances that it can be hard to answer every question, but here are some general answers to common concerns.
Who is eligible for a bridge loan?
Bridge loans are typically reserved for borrowers with a strong credit history and credit score. While the minimum credit score will vary by lender, a higher credit score will always mean a lower interest rate.
With a bridge loan, you’re likely to experience a faster application time, as well as a faster approval and funding process, than you would with a traditional loan. You therefore won’t have to wait as long to get the funds needed to move forward with that second home purchase.
Debt-to-income ratio, loan-to-value ratio, credit history and credit score (FICOⓇ Score) all matter when seeking a bridge loan. You’ll need to have a lot of equity in your current home to qualify, and since you can borrow up to 80% of your home’s value, this math doesn’t always work. It only works if your home has appreciated from when you purchased it or you’ve made a significant dent in the principal balance owed.
What is the main benefit of a bridge loan?
The main benefit of a bridge loan is that it can allow you to place a contingency-free offer on a new home. In a competitive housing market, fewer contingencies can make the seller more likely to consider your offer when they’ve received multiple offers.
When would I need a bridge loan?
Bridge loans provide convenience if your family needs to move quickly, whether it be for purposes of relocating for a job or something even more urgent. If you’re in a market where homes languish on the market, you might need to move before you have adequate time for your home to sell.
On the other hand, if your house sells before you buy another home, you might need to take the expensive, inconvenient step of moving into temporary housing. A bridge loan can help you avoid this.
What are the drawbacks of bridge loans?
Bridge loans can come with a high price tag because you absorb a higher interest rate and the fees associated with an additional mortgage. There’s also the matter of how long a bridge loan is for. Since a bridge loan is short-term, you’ll have to pay it back quickly. This can be especially stressful if it takes longer to sell your house than expected.
Even if you anticipate repayment of the loan with no problems, unexpected circumstances can complicate your plans. Just having two mortgages to manage can be stressful, no matter your economic circumstances.
You might have to look for a different lender than the one that provided your primary loan. Be sure to ask your current lender about this, though, since they might be able to help you or at least offer a great reference.
The Bottom Line: Bridge Loans Are For Some People, But Not Everyone
As with any financial vehicle, there’s no one-size-fits-all answer on whether a bridge loan is right for you. It depends on your financial situation, your living situation, the economy and other factors.
Always weigh all the pros and cons of any mortgage loan before taking the plunge. Make sure you work with a lender who will walk you through all your options and help you make the decision that’s best for you and your needs.
Are you trying to buy a new house while selling your current home? Get started online to see how you might be able to secure some extra cash to make your move less stressful.