As its name suggests, a bridge loan offers a short-term loan or “bridge” that allows borrowers to purchase new real estate property by using the home they currently own as collateral. Here, realtor.com explains why a bridge loan can be worth considering for borrowers who are trying to buy and sell a home at the same time.
What is a bridge loan?
Also called a “wrap” or “gap financing,” bridge loans are a lifeline for homebuyers who are eager to purchase a new house before selling their current one. In these type of scenarios, unless you have substantial income and lots of cash for the down payment, it can be difficult to qualify for the loan amount of the new home while you are still paying a monthly mortgage on your current home—for many people, that means stretching their finances. Lenders typically know that the odds are good that the borrower will sell the old house soon enough, and a short-term bridge loan will help span that gap.
How bridge loans work
Typically, for a bridge loan, you can finance up to 80 percent of the combined value of both homes. So if you’re selling a home for $200,000 and buying another one for $300,000, you can borrow a maximum of $400,000. As for the rest (in this case, $100,000), you’ll need that either in home equity, savings for a down payment or some combination of the two. Once your home sells, you pay off the bridge loan and then apply for a new longer-term mortgage with a more favorable interest rate to refinance just your new home.
Bridge loans typically take a shorter time to process than conventional loans (a couple of weeks versus a few months) and are meant to be short-term solutions (often three months to a year). They typically have a higher interest rate and fees than on a standard home loan, so the idea is to pay the bridge loan off as quickly as possible, as soon as you sell your previous real estate.
Pros and cons of bridge loans
With one of these loans, you can make an offer on a new home without a financing contingency. That means that you’ll buy the home only if you can secure a new mortgage. Odds are, the person selling the home you hope to buy doesn’t like financing contingencies, since that would mean that your offer is not a sure thing. A bridge loan solves this home-buying problem by guaranteeing the cash needed to close the deal.
Still, bridge loans require an excellent credit score and a low debt-to-income ratio, so you should take time to consider what a bridge loan will do to your long-term finances. Even if you’re fairly certain you’ll sell your current home quickly and can pay off this high-interest loan, the real estate market is never a sure thing, and there’s always a possibility that your old home will take far longer to sell than you imagine. Then you’re stuck paying high-interest rates and big mortgage payments—and if you can’t pay up at the end of the loan term, you could end up losing your home to foreclosure. That being said, most bridge loan lenders are willing to extend the deadline on a bridge loan.
Is a bridge loan right for you?
Whether you should get a bridge loan or not depends on your specific market area. As a general rule, it’s a good gamble if your home is situated in a hot seller’s market, where you are reasonably assured that it will sell in a short time. If you’re in a buyer’s market, however, where your home might sit on the market for months or years, it’s much wiser to sell your house and rent something for a short time until you find another home you love. That means you’ll have to move twice—once into your rental, then once again after you buy a home—but that hassle will pale in comparison to the stress you’ll face when the clock is ticking and you’re making mortgage payments on a bridge loan.
