What is a bridge loan and how does it work?
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Key takeaways
- Bridge loans are short-term loans that help cover costs during transitional periods, most often the time frame between buying and selling a home.
- Like a mortgage, you might need to put your home up as collateral for a bridge loan. Some bridge loans allow you to pledge other assets instead.
- Many lenders only offer bridge loans if you agree to work with them on financing your next home purchase.
If you’re moving between homes — especially with little notice — a short-term bridge loan can help cover costs, but it also carries some risks.
What is a bridge loan?
A bridge loan — also referred to as a gap loan, hard money loan or swing loan — is a short-term loan that typically helps with financing when moving from one house to another. Bridge loans are often secured by your current home as collateral, but some allow for other types of assets.
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.
Bridge loan vs. traditional loan
The primary difference between a bridge loan and a traditional loan is the timeline for repayment. The term on a bridge loan typically lasts six to 12 months, while the term on a mortgage can be up to 30 years. In addition, lenders fund bridge loans faster compared to traditional mortgages — sometimes in as little as two weeks.
How does a bridge loan work?
Bridge loans vary widely in structure, cost and terms. If you qualify, you could borrow a relatively large sum, 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 balloon 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. Some last up to three years.
- Lenders rarely extend a bridge loan unless the borrower agrees to also finance the new home’s mortgage with that lender.
- Rates can range anywhere from the prime rate to the prime rate plus 2 percentage points.
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 a score 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
Pros of bridge loans
- Cash in hand quickly: A bridge loan is good for time-sensitive or quick transactions. Some lenders can fund in as few as two weeks.
- Payment flexibility: You can defer payments until your current home sells, or make interest-only payments.
- No contingency needed: Rather than place a contingency on your new home purchase that your old home must sell for financial reasons, a bridge loan provides the funds to settle on your new home even if the old one hasn’t sold yet.
Cons of bridge loans
- Equity requirements: Many lenders require at least 20 percent equity in the current home. This can be a barrier to entry for some.
- Financing requirements: The lender might only extend a bridge loan if you agree to use it for your new home mortgage.
- Higher rates: Bridge loans usually have higher interest rates and APRs compared to traditional mortgages.
- Limited borrower protections: Bridge loans 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, or if you were to have trouble selling your current home.
How to apply for a bridge loan
The process of applying for a bridge loan is similar to applying for a regular mortgage:
- Determine your home equity level. This is the difference between the value of your current home and the outstanding balance of your current mortgage. Most lenders only allow you to borrow up to 80 percent or 85 percent of your equity.
- Shop for a lender. Some bridge loan lenders include CoreVest, Guild Mortgage and Knock. Not all mortgage lenders offer bridge loans, however.
- Understand your options. When you find a lender you like, contact a loan officer to learn about requirements and how their bridge loan program works — remember, not all lenders structure bridge loans the same way.
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
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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.
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A bridge loan can span anywhere from six months to three years, though some lenders might offer longer repayment timelines. There’s usually a fixed deadline by which the entire loan amount must be repaid.Typically, you’ll pay interest-only installments initially, or no payments at all, then a final lump-sum payment due at the conclusion of the term. Ideally, you’d structure the loan so that proceeds from your home sale coincide with the full repayment or the start of the repayment period.
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While the funding timeline varies from lender to lender, some can provide loan proceeds in as little as two weeks.
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