What Is A Bridge Loan And How Does It Work? | Bankrate (2024)

DenisTangneyJr/Getty Images

If you’re moving between homes — especially with little notice — a bridge loan can help cover costs. This short-term form of financing can, true to its name, bridge a cash-flow gap. But it also carries some risks.

What is a bridge loan and how does a bridge loan work? Here’s an overview to help you make a more informed decision.

What is a bridge loan?

A bridge loan — in some cases referred to as a hard money loan — is a short-term loan designed to provide financing during a transitionary period, such as moving from one house to another. Bridge loans are often secured by your current home as collateral, just like mortgages, home equity loans and HELOCs. Sometimes, however, you can use other assets as security.

Homeowners faced with sudden transitions, such as having to relocate for work, might prefer a bridge loan to help with the costs of buying a new home: covering the down payment or managing simultaneous mortgage payments for two properties. Real estate investors often rely on bridge loans, as well, when flipping properties.

How does a bridge loan work?

A tool typically used in a temporary cash crunch, bridge loans vary widely in structures, costs and conditions. If you qualify, you could borrow a relatively large sum with a bridge loan, anywhere from several hundred thousand dollars to more than $1 million.

For example, a bridge loan mortgage might involve cashing out equity from your current home and putting that toward a down payment on a new property — or, simply taking out a bigger mortgage for the new property. Another type of bridge loan uses both homes as collateral. Some carry monthly or interest-only 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 or 12-month terms and are secured by the borrower’s old home.
• Lenders rarely extend a bridge loan unless the borrower agrees to finance the new home’s mortgage with them as well.
• Rates can range anywhere from the prime rate to the prime rate plus 2 percentage points.

When to consider a bridge loan

Home bridge financing is used most often when a homeowner plans to buy a new home before selling their current one. A bridge loan might be a good fit if:

• You found a new home, but the seller won’t accept a contingency mandating you sell your current home.
• You can’t come up with the down payment for a new purchase unless you sell your current home.
• Your closing date for your current home is after your settlement for the new one.
• You’ve found your new dream home in a seller’s market — and you need cash fast to beat out the competition.

Bridge loan requirements

• Credit score: Because bridge loan lenders have much more underwriting flexibility, you might be able to get a bridge loan with a credit score as low as 500. Other lenders require scores in the high-600s.
• Debt-to-income (DTI) ratio: Some bridge loan lenders allow a DTI ratio as high as 50 percent.
• Equity: If you’re taking a traditional bridge loan, many lenders require at least 15 percent equity in your current home. Others require 20 percent.

Pros and cons of bridge loans

How to apply for a bridge loan

The process of applying for a bridge loan is similar to applying for a regular mortgage. Here are the likely steps involved:

1. Determine how much home equity you’ve accrued. This is the difference between the current value of your home and the outstanding balance of your mortgage — in other words, the portion of your home’s value you own outright. Most lenders only allow you to borrow up to 80 percent of your current home’s equity.
2. Check your credit score. Aim for a high credit score to qualify for the best bridge loan rate and term. You can purchase your score from the major credit bureaus — Equifax, Experian and TransUnion — and even directly from FICO. Or, you may be able to obtain your score for free. Several credit card companies offer credit reporting and scoring as a benefit to cardholders. Card issuer offerings include American Express MyCredit Guide, Citi’s Card Benefits, Capital One’s Credit Wise, Chase’s Credit Journey and Discover’s Credit Scorecard. The services offered by American Express, Capital One and Discover are available to anyone — not just cardholders.
3. Contact your current bank lender. Learn if they offer bridge loans and what you qualify for.
4. Shop around among different lenders. This can often yield the best deal. You can compare your offers and choose the best loan for your needs. Remember that lenders evaluate several factors regarding your creditworthiness, such as your credit score and DTI ratio. Keep in mind that bridge loans can be costly to get, too: Closing costs are usually a few thousand dollars, up to 3 percent of the loan’s principal.
5. Once you’ve chosen a lender, complete the application for a bridge loan and await an underwriting decision.

Current bridge loan mortgage rates

If you’re interested in a bridge loan, be prepared for potentially paying a higher interest rate than you would for a standard conventional mortgage loan. Many lenders base their bridge loan rates on the prime rate (currently at 8.5 percent), while others set their rates a couple of percentage points higher than the prime. Bridge loans generally have higher rates because they’re short-term financing solutions that provide funds quickly. Lenders charge more for this convenience.

Bridge loan FAQ

• Bridge loans typically have higher interest rates than traditional mortgages, which increases your borrowing cost. In addition, you’ll also have to consider closing costs, which total 1 t0 3 percent of the borrowed amount. There are both mortgage-related and property-related fees that can be included in closing costs, which vary in cost by location and lender. These include application, appraisal, credit report, escrow, home inspection, origination, underwriting title insurance and title search fees.
  

• If you’d prefer to explore other options, the following could be ideal:

  • Home equity loan: If you know exactly how much you need to borrow to put a down payment on your new home, a home equity loan might be a solution. You’ll receive a lump-sum payment against the equity in your current home. These loans are longer-term, usually allowing repayment of up to 20 years, and typically have more favorable interest rates compared to a bridge loan.
  • HELOC: A home equity line of credit (HELOC) is similar to a home equity loan in that it draws against the equity of your current home, but it functions like a credit card. The interest rate is only charged if you access the money, and might be lower than that of a bridge loan. However, this might not be an option with your lender if your current home is up for sale.
  • 80/10/10 loan: With an 80/10/10 loan (also known as a piggyback loan), you put down 10 percent and finance two mortgages — the first mortgage for 80 percent of the purchase price and the remaining 10 percent is a second loan. You can use this bridge loan financing alternative and then pay off the second mortgage when your current home sells.
  • Business line of credit: A business line of credit works like a HELOC and only accrues interest on money drawn against it. Loan terms vary by lender but usually allow up to 10 years to pay. These loans are more difficult to get and may have a higher interest rate than a bridge loan.
  • Personal loan: If you have good credit and a lower DTI ratio, you could get a personal loan with a better interest rate than a bridge loan mortgage. The terms and conditions, such as collateral in the form of personal assets, vary by lender.

• A bridge loan loan usually extends for a set period, often one year before repayment starts. Term durations typically span from six months to three years, though certain lenders might permit longer repayment timelines. There’s generally a fixed deadline by which the entire loan amount must be repaid. Initial payments for bridge loans commonly consist of interest-only installments, or they may be postponed, with a final lump-sum payment due at the conclusion of the term. Ideally, you can structure the loan so that proceeds from your home sale can coincide with the repayment or the start of the repayment period.