A bridge loan is a short-term loan that borrowers use to finance a purchase while they secure long-term funding. They typically have higher interest rates and more expensive fees than regular mortgages. Both individuals and businesses make use of bridge loans. Individuals most often use them to help fund the purchase of a new home while a current home is still up for sale.
Imagine you are in the process of selling your old home and buying a new one. You have found your dream home and are ready to make a down payment. However, your old home is still on the market, and you’re relying on the profit from the old home for your down payment on the new one. If you are certain your old home will sell and can’t bear losing your dream home to another buyer, taking out a bridge loan may be a good option for you.
A bridge loan eases the financial pressure many borrowers face as they look to make big purchases. This short-term loan fills the gap between when you need some sort of funds and when you can secure long-term funding.
What is a bridge loan?
A bridge loan is a short-term loan, typically up to one year, that borrowers use until they can secure long-term financing or remove an existing obligation. This immediate cash flow comes with a cost: these loans typically have high interest rates and have to be backed by some form of collateral, such as real estate or other assets. Bridge loans may also be called bridge financing or bridging loans.
How do bridge loans work?
Bridge loans do as their name suggests — they bridge the gap during times when financing is needed but not available, for whatever reason. Borrowers commonly use bridge loans to cover down payments and closing costs for real estate purchases. Both individuals and corporations employ bridge loans. You can apply for a bridge loan through your lender, but the terms and conditions of bridge loans vary across lending institutions.
Common requirements and most common use
Lenders offer bridge loans but may have unique situations in which they will approve such a loan. For instance, lenders typically limit the amount of a bridge loan to 80% of the unencumbered value of the property the borrower is using to secure the loan. In the case of homes, another term for unencumbered value is equity.
The most common examples of bridge loans are when homeowners try to purchase new homes while still selling their current homes. These homeowners apply for bridge loans using their current homes — which have yet to sell — as collateral. The bridge loan funds cover their down payments on the new home purchases.
Since your home equity is the value of your home minus the remaining balance of your mortgage, whether you get approved for a bridge loan or not will depend on how much equity you have in your home. By allowing you to borrow against this equity, a bridge loan gives you more time to sell your current home without losing out on the new home you want to buy.
Bridge loans can reduce the stress involved with buying and selling at the same time. They do come with higher interest rates than other financing, however.
How to qualify for a bridge loan
You will only qualify for a bridge loan if you have excellent credit. Lenders will look at the following factors when deciding whether or not to give you a bridge loan:
- At least 20% equity in your home.
- Enough income to afford to make multiple loan payments. They will look at your cash flow and any savings you may have.
- Your housing market. If your house is in a good market and is expected to sell quickly, they are more likely to offer you a bridge loan.
- An excellent credit history that shows you can responsibly handle debt.
Using a bridge loan for individual real estate
If you are a current homeowner and thinking of selling then quickly buying, you may want to consider a bridge loan. First, you need to talk to your lender about qualifying for a bridge loan. Your lender will evaluate your qualifications and financial standing, such as your debt-to-income ratio, your home equity, your credit score, and your income.
What makes you more likely to qualify?
You are more likely to qualify for a bridge loan if you have successfully been making your mortgage payments. You should also have excellent credit standing and a low debt-to-income ratio. On the flip side, as already noted, you will need sufficient equity in your current home to qualify for a bridge loan. A home without equity isn’t ready to secure a new loan.
How soon will you be approved?
In most scenarios, you will experience a faster approval process for a bridge loan than you would for a traditional mortgage. Bridge loans typically get approved (or disapproved) quickly. Their purpose is to provide immediate cash, and slow processing would defeat that purpose.
How can a business use a bridge loan?
Though this article focuses primarily on bridge loans as they are most often used by consumers, you’ll hear other loans than these called “bridge loans.” Business or commercial bridge loans resemble consumer bridge loans in important ways, but they are not identical.
Businesses use bridge loans in scenarios where they expect long-term financing to come through soon, but need some source of funding to cover expenses in the interim. A company might use the bridge loan to cover its payroll, rent, and other expenses until the expected funding comes through.
Although any business loan used to cover expenses over a shorter term could be called a bridge loan, bridge loans taken out by businesses are often for real estate transactions, just like consumer bridge loans. Also like consumer bridge loans, the commercial variety will require collateral, have higher interest rates, have shorter terms, and get approved (or disapproved) more rapidly than other loans.
When do I repay my bridge loan?
The typical length of time to pay off a bridge loan is one year. The repayment terms vary across lenders. In most cases, you will make interest-only monthly payments until your home sells. If you reach the end of the loan term without having sold your home, you’ll need to pay it back, make new arrangements with your lender (such as getting a new loan that pays off the first), or face foreclosure.
Avoid making a deposit or starting repayment before your home sells
Generally, it’s better to avoid bridge loans that require a deposit. Your goal should usually be to only pay the loan principal when your home sale closes. You should only apply for a bridge loan if you plan to use the money from the sale of your home to repay the loan. If your loan is secured by the property you’re selling, you won’t be able to complete your sale until this encumbrance is cleared.
Even if you arrange a bridge loan that’s secured some other way, such as by a second mortgage on a piece of investment property you’re not going to sell, the comparatively high rates on these loans make any delay in repayment unwise. The only possible exception to this rule would be avoiding early repayment of a bridge loan with a prepayment penalty.
Paying your bridge loan off with sales proceeds as soon as you have them ensures that you are quickly able to repay the loan and avoid paying too much interest at the high rate. When you apply for the loan, you should also look for a “final due date” for when the loan needs to be entirely paid back. If this is unclear, make sure to work out these terms with your lender to make certain you can fully pay back the loan on time.
Bridge loan fees
Fees for bridge loans vary across lending institutions. Here’s a rundown of some common fees:
- Origination fees. Most bridge loans come with a high origination fee, which you should expect to pay when you apply for the loan.
- Escrow and title fees. You will also have to pay these fees when you take out a bridge loan.
- Prepayment penalty. Some bridge loans may also have a prepayment penalty if you pay off the mortgage early. This could be an especially bothersome fee if your bridge loan is secured by the home you have up for sale. Since you’ll have to pay off this loan as part of the sales process, avoiding the prepayment penalty could be challenging. Unless you’re using some other property as collateral, you may wish to think twice before accepting a bridge loan with a prepayment penalty.
- Closing costs. When the sale closes, expect to pay 1.5% to 3% of the loan amount in closing costs.
While thinking about these fees, also keep in mind that the interest rates for bridge loans are typically higher, up into the 8%–10% range as of this writing (late April 2022).
Pros and cons of bridge loans
Here is a list of the benefits and the drawbacks to consider.
- Relatively quick application and funding process.
- If you compete with other potential buyers for a home, a bridge loan can give you an edge. There are fewer financial contingencies, and sellers may see you as more sure to close if you have a bridge loan.
- Reduces the stress involved with trying to sell and buy at the same time. You can take more time to sell your current home.
- Keeps your savings intact.
- Typically only required to make interest-only payments until the home closes.
- You can move to your new home without having to rent a short-term house or pay for storage.
- A short-term loan means that you will not be making payments for a long time.
- High interest rates can become challenging if you are unable to use the money from your sale to pay off the loan. This is possible if you use property other than the home you’re selling as collateral, allowing the sale to go through with the bridge loan outstanding.
- Two payments, the mortgage on your new home and the bridge loan, once the deal closes. This is only a risk if your bridge loan doesn’t have to be paid off to allow your home sale to go through, that is if you’ve secured the loan with another property.
- Risk of foreclosure because your home is being used as collateral. If your home does not sell and you do not repay the loan, the lender has the right to foreclose on your home.
Alternatives to a bridge loan
You do have several alternatives to a bridge loan. These include home equity lines of credit, traditional home equity loans, cash-out refinancing, and more.
Home equity line of credit
Provided you plan ahead and take out the loan before you put your home up for sale, a home equity lines of credit (HELOC) is a alternative to a bridge loan, and HELOCs have lower interest rates. If you have yet to pay off your mortgage, consider that you will now have to make two payments until you sell your home: the HELOC and the first mortgage.
If approved for a HELOC, you can borrow as much money as you need up to your credit limit. This means that if you have a lot of equity in your home, you could potentially borrow enough to make a down payment on a new home. You would then pay off the line of credit when your home sold. Your home is used as collateral in this alternative.
Home equity loan
While bridge loans and traditional or standard home equity loans both use your home as collateral, they are not the same. To take out a standard home equity loan, you’ll have to apply and get approved for the home equity loan before you put your property on the market.
A home equity loan, like a HELOC, is a subordinate mortgage on your home and will need to be paid off with proceeds from any sale. Also like a HELOC, it should get you a better interest rate than a bridge loan. With this option, you start repaying the loan immediately, so, if you have a first mortgage still outstanding, it will mean a second monthly payment while you try to sell your home.
Yes, by the way, a bridge loan secured by your for-sale home is also a subordinate mortgage that you’ll need to pay off to complete the sale of your home. The main differences between this type of bridge loan and a standard home equity loan are when you can get it and how long you have to pay it off. The purpose of a bridge loan may also mean it will be smaller than the largest home equity loan or HELOC you could qualify for (why borrow more than you need at bridge-loan rates?), though this depends on how much equity you have.
In this alternative, you refinance the mortgage on your current home to secure enough to pay off your mortgage and make a down payment on a new house. You need enough equity in your current home to make this a feasible option. As with the two prior options, you will likely need to get this loan approved before you put your home up for sale. Lenders don’t typically want to make loans against properties that are already on the market, with bridge loans being a notable exception.
80-10-10 piggyback loan
Instead of refinancing or taking out a home equity loan or line of credit on your existing home, you take one out on the new home to cover 10% of the down payment. Normally, you would take out a home equity loan at the same time as the mortgage on your new home, using it to pay 10% of the down payment.
Bridge loans use your on-sale home for security, meaning you’ll only get approved for one if your home has enough equity to make it worth accepting as collateral. It may also be possible to get the funds you need without providing collateral, or using collateral other than the home you’re trying to sell.
If you have valuable property other than the home you have on the market, you may be able to use that property as collateral for a secured personal loan. If you have excellent credit and income, you may be able to get an unsecured personal loan that meets your needs. Click here to read about some of the best personal loan products.
Knowing more about the personal loan industry could help you navigate loan offers more intelligently. To learn more about the personal loan industry, click here.
Do you need an appraisal for a bridge loan?
Yes, you need an appraisal for a bridge loan. A bridge-loan lender needs to evaluate the cost of your house to decide how much to let you borrow against it.
How much can you get with a bridge loan?
The amount you can get with a bridge loan depends on the value of the home you’re using as your collateral. The maximum you can typically expect to be offered in a bridge loan is 80% of your home’s available equity.
Is interest on a bridge loan tax deductible?
Yes. If your bridge loan is secured by your home, meaning it’s a mortgage, then your interest payment will be just as tax-deductible as interest payment on any other mortgage.
- Bridge loans are short-term loans that bridge the gap between when you need funds and when you expect those funds to come in through a long-term solution.
- Bridge loans are commonly used in real estate when individuals are trying to buy and sell at the same time.
- Businesses may also use bridge loans for real estate purchases and other purposes. This article has focused on bridge loans used by individuals rather than businesses.
- Bridge loans have a short term, typically around one year, and have high interest rates to make the loan worthwhile to the lender.
- There are alternatives to bridge loans that might better suit your financial needs. Make sure you talk to your lending institution to evaluate your options and make the best financial decision possible.
View Article Sources
- Personal Loans: Secured vs. Unsecured — National Credit Union Administration
- Relevant articles by Chase Bank, Rocket Mortgage, and money management sites — Various
- What is a home equity loan? — Consumer Financial Protection Bureau
- What is the difference between a Home Equity Loan and a Home Equity Line of Credit? — Consumer Financial Protection Bureau
- Best Personal Loans — SuperMoney
- Personal Loans Industry Study — SuperMoney
- Ultimate Guide to Secured Personal Loans — SuperMoney
- Ultimate Guide to Unsecured Personal Loans — SuperMoney
- What Is a Subordinate Mortgage? — SuperMoney
- What is the Principal of a Loan? Definition & Examples — SuperMoney
- What Is an 80-10-10 Mortgage Loan and How Does It Work? — SuperMoney