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What is a bridging loan?
A bridge loan (also known as a gap loan or swing loan) is a short-term loan that typically helps you finance a move from one home to another. Bridge loans are often secured by your current home, but some can be secured by other types of assets.
If you need a new home before your old one sells and you need extra cash for the down payment and additional monthly mortgage payments, you can take advantage of a bridge loan. Real estate investors who sell properties also often rely on bridge loans.
How do bridge loans work?
Bridge loans vary widely in structure, cost, and terms. If the conditions are met, you can borrow relatively large sums ranging from tens of thousands of dollars to more than $1 million.
Features of bridge loans include:
- the purpose: A bridge loan may involve cashing out the equity in your current home and using it to make a down payment on a new property, or simply taking out a larger mortgage on your new property. Another type of bridging loan uses both homes as collateral.
- interval: Bridge loan terms are typically 6 to 12 months, although some lenders offer terms as short as 3 months.
- clause: Some bridge loans result in interest-only payments initially and a lump sum repayment at the end of the loan term. In other cases, you may not need to make a down payment until you sell your home.
- Fee: Rates range from the prime rate to the prime rate plus 2 percentage points.
Bridge loan example
Let’s say your home is currently worth $300,000 and you have a $50,000 mortgage balance. If you get a $70,000 bridging loan, you can use $50,000 to pay off your mortgage and an additional $2,000 for loan closing costs. That way, you’ll have $18,000 for your next purchase.
Comparison of bridge loans and traditional mortgages
The main difference between a bridge loan and a traditional mortgage is the repayment schedule. Bridge loan terms are typically six to 12 months, while mortgage terms can be up to 30 years. Additionally, lenders will fund bridge loans faster than traditional mortgages, sometimes in as little as two weeks.
When should I take a bridging loan?
Bridge loans can be a valuable financing option for certain people, including:
- Homeowners who need a down payment when purchasing a new home: A bridge loan is useful if you want to buy a new home but have not yet sold your existing home. The funds from your loan can help you cover the down payment on your new home.
- Investor flips a house: If you’re in the business of buying renovated homes, renovating them quickly and selling them, a bridging loan can be a useful financing option.
However, using bridge loans comes with risks. First, you need a plan to pay back the funds quickly, often within a year. If the house you currently live in does not sell and you are unable to repay the loan, it may be foreclosed on. Additionally, like any loan, bridge loans have closing costs that can cost thousands of dollars.
Bridging loan requirements
As with other types of mortgages, you must meet several requirements to qualify for a bridge loan, including:
- Credit score: Credit score requirements vary by lender, but a minimum score of 680 is often required to qualify for a bridge loan.
- Debt-to-income (DTI) ratio: Some bridge loan lenders allow DTI ratios up to 50%.
- capital: For traditional bridge loans, many lenders require at least 15% to 20% equity in your current home.
How to apply for a bridge loan
The application process for a bridge loan is similar to applying for a regular mortgage.
- Determine your home equity. This is the difference between the price of your home and your current mortgage balance. Most lenders will only allow you to borrow up to 80% or 85% of your equity.
- Shop around for lenders. Many mortgage companies don’t offer bridge loans, but CoreVest, Guild Mortgage, and Knock do.
- Understand your options. Once you find a lender you like, contact the loan officer to learn about your requirements and how the bridge loan program works. Keep in mind that not all lenders structure bridge loans in the same way.
Bridge loan alternatives
If you’re not comfortable taking out a bridge loan, consider one of these other options:
- Home equity loan: If you know exactly how much you need to borrow for the down payment on your new home, a home equity loan may be the solution. You can receive the loan in a lump sum, but you can also pay it back over 20 or 30 years. Home equity loans typically have more favorable interest rates than bridge loans.
- Herock: A home equity line of credit (HELOC) is similar to a home equity loan in that it taps into the equity in your current home, but it works like a credit card. You can withdraw money as needed up to a certain limit. You will only be charged interest if you access the line of credit. However, if your current home is for sale, you may not be eligible for a HELOC.
- 80/10/10 Loan: With an 80/10/10 loan (also known as a piggyback loan), you receive two mortgages with a 10% down payment. The first is 80% of the purchase price and the second is 10%. As an alternative to a bridging loan, you can also take out a small mortgage and pay off your second mortgage once your current home sells.
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—Taylor Freitas contributed to this article.