Everything you need to know about bridge loans
When you find a home you love in a hot seller’s market, you can’t always wait until your current home has sold to make an offer. Yet buying before you sell can be tricky. If you don’t have enough cash in savings, how do you finance your next down payment?
There are plenty of short-term loan options you could use in that situation—and bridge loans are one of them. In this guide, you’ll learn how bridge loans can help you afford your next home before you have to sell your current one. It’s one of the many ways Flyhomes can help you buy before you sell. When you’re ready for a new home, start with Flyhomes.
What you’ll learn:
- What a bridge loan is
- How a bridge loan can help you purchase your next home before selling your current one
- How much a bridge loan costs and how it works
- Pros and cons of bridge loans
- Short-term financing alternatives to bridge loans
What exactly is a bridge loan?
In real estate, bridge loans are short-term loans that homebuyers use to “bridge the gap” between buying a new home and selling their current one. They’re also known as swing loans, bridge financing, gap financing, and bridging loans.
In a bridge loan, the borrower’s current home serves as collateral so if you can’t pay it back, the bank could take possession of your home. Because of this, most lenders require the borrower to have at least 20% equity in their property. This can make it harder to qualify for bridge loans.
Loan terms and requirements vary, but in general, you can borrow a maximum of 80% of your current home’s value. A bridge loan’s term length typically runs anywhere from six months to a year. Because the life of the loan is so short, interest rates are often higher than you would find with a personal loan or traditional mortgage.
How a bridge loan can help you buy your next home
In a perfect world you’d be able to sell your current home and buy your next one on the same day to use your proceeds for a down payment. But real estate is never that simple, is it?
Let’s say you got a new job in a different city that starts in two weeks. You need to buy a new home as soon as possible, which means you may not have time to sell your current one first.
That’s where bridge loans come in. These short-term loans can fund your entire down payment or supplement your savings so you can make a 20% down payment and avoid private mortgage insurance (PMI).
Bridge loans also allow you to make an offer that isn’t contingent on the sale of your current home. This is especially helpful in a seller’s market when non-contingent offers often win over other bids.
How much does a bridge loan cost?
Since they’re so short-term, real estate bridge loans tend to have higher interest rates than other types of financing. Rates can be as high as 8.5-10.5%, depending on the market. If you have excellent credit and a very low debt-to-income ratio (DTI), you may be able to get a rate as low as 6%, but this depends on the market and your location.
You also have to pay closing costs, which can be several thousand dollars or 1.5-3% of the overall loan amount. Your closing costs may include various fees, such as:
- Legal fees
- Administrative or application fees
- Appraisal fee
- Home inspection fee
- Escrow fee
- Title policy fee
- Notary fee
- Credit search and report fee
- Loan origination fee
- Underwriting fee
How a bridge loan works
There are two main ways homeowners can take out a bridge loan:
1. Maintain two distinct loans
The loan can be up to 80% of your home’s value minus your current mortgage. So, if your home is worth $500,000, but you still owe $250,000 on it, 80% of its value ($400,000) minus your current mortgage ($250,000) makes your bridge loan eligibility $150,000.
Funds from the bridge loan can then be put toward your next down payment. In this case, you make payments on the bridge loan and your first mortgage with the goal of paying them both off once you sell your first home.
So, using those same numbers from before: you will owe $350,000 in total on the loans you have against your home—the $250,000 left on your mortgage and the $150,000, plus interest, you borrowed as a bridge loan for your next down payment. Once your home sells, you can pay off these two loans with the proceeds.
2. Hold one comprehensive loan
In this scenario, you take out a bridge loan of up to 80% of your home’s value. Those funds first go toward paying off your current mortgage. Then you can use the remainder to make a down payment on another home.
In most cases, you have to repay the principal by the end of the loan term—hopefully with the proceeds of your old home’s sale. But different lenders may structure interest payments in various ways. Some require monthly interest payments while others request that it be paid as a lump sum either at closing or at the end of the loan term.
Bridge loans: pros and cons
Is a bridge loan right for you and your situation? Before making a decision, you should analyze your finances and consider the advantages and disadvantages of this type of loan. Here are the basic pros and cons of bridge loans:
- Faster underwriting process than long-term financing
- Quick access to funds
- Usually no prepayment penalties
- Ability to buy a new home before selling (without PMI)
- Competitive option in a seller’s market
- Higher interest rates and APR than most traditional loans
- Steep origination fees
- Stricter requirements for credit score, DTI, and home equity amount
- Difficulty paying two mortgages at once (if applicable)
Another disadvantage is the risk of not being able to sell your current home before the bridge loan term is up. If this happens, you have to find another way to repay the loan, or your lender could foreclose on your home.
Right now, this is less of a risk than it may be in other markets since the housing market is so competitive. Owners are having no trouble selling their homes.
Other ways to buy your next home
While bridge loans can be a helpful way to buy before selling, they’re not your only option. Other short-term financing options allow you to tap into your home equity to buy your next home.
A home equity line of credit (HELOC) functions like a credit card because you can withdraw funds up to a certain amount within a specific timeframe. This amount is determined by how much equity you have.
You typically need to repay the HELOC within 10 to 20 years. And since its interest rates are variable (meaning they fluctuate with the market), your monthly payments will likely change during that time.
Home equity loan
Unlike HELOCs, home equity loans provide funds in a lump sum, which you must repay with interest. This loan functions like a second mortgage, which you can repay over a span of five to 15 years or once your current home sells. Interest rates for home equity loans are fixed, which means your monthly payments won’t change with the market.
An 80-10-10 loan is actually two separate loans. You first take out a primary mortgage of 80% of your new house. To make a 20% down payment (and avoid PMI), you pay 10% out of pocket and take out a second mortgage for the remaining 10%.
Once your current home sells, you can repay the secondary 10% loan and keep paying down the long-term mortgage.
All-in-one loan solution
For a stronger competitive advantage, certain programs allow homebuyers to take out a short-term loan on their current home so they can make an all-cash offer on their next one.
For example, Flyhomes’ Buy Before You Sell program lets you move into your new home while we work on selling your current one. Once it sells, you pay back the short-term loan and get set up with a long-term mortgage.
Afford your next home with a bridge loan
Bridge loans can be a fast way for homeowners to buy a new home before selling their current one. But since they tend to be more expensive, it’s important to consider all of your short-term financing options and choose what works best for you. With the right short-term loan, you can buy a home you love without wasting precious time and energy trying to sell first.
About the author: Jenny Rose Spaudo is a Central Florida homeowner and a copywriter/content strategist specializing in real estate and finance. She’s worked for clients like Edward Jones, Flyhomes, PropStream, and Knock and has written for publications like Business Insider and GOBankingRates. Visit her website and connect with her on LinkedIn.