A bridge loan is a short-term loan used to provide immediate cash flow when financing is impending but not available right away. Bridge loans are sometimes also known as swing loans, gap financing, or interim financing. Homeowners typically use these loans to cover the cost of new property before they can sell their current house.
Overview of a bridge loan
Moving homeowners often rely on the money they will get from the sale of their current home to fund the purchase of the new one. Unfortunately, the timing doesn’t always work out and consumers may need to buy the new home before the old one is sold. Bridge loans provide a solution by bridging the gap between the new purchase and the sale of the old home, which is used as collateral. “Borrowers use the equity in their current home for the down payment on the purchase of a new home,” explains personal finance editor Julia Kagan. “This happens while they wait for their current home to sell.”
The terms of the loan can vary. Most run for six months, but can last for up to a year and typically have interest rates between 8.5 and 10.5 percent, making them more expensive than long-term financing options. Payment methods for the loans can also vary. “Some carry monthly payments, while others require either upfront or end-of-the-term, lump-sum interest payments,” says mortgage reporter Zach Wichter.
Benefits of a bridge loan
The main benefit of a bridge loan is it buys you time. In a competitive housing market, you may not be able to delay closing on a new home for even a short period. “This gives the homeowner some extra time and, therefore, some peace of mind while they wait,” Kagan says. Bridge loans also remove contingencies from your purchase offer, making it more appealing to sellers. Additionally, getting a bridge loan secured is usually faster and easier than getting a traditional loan, especially if you already qualify for a mortgage to purchase a new home.
Businesses may also use bridge loans to cover operating expenses while the business awaits long-term financing, or to quickly take advantage of a limited opportunity to acquire real estate or other such beneficial resources.
Drawbacks of a bridge loan
Bridge loans come with several drawbacks compared to other options. One of the most significant is the interest rate, which is high because lenders have less time to make money otherwise.
Other downsides include having to pay for an appraisal as well as origination and closing fees that can run as high as three percent of the total loan. Furthermore, because bridge loans use your current home as collateral, lenders often require you to have a good amount of equity in your home to qualify, usually more than 20 percent.
Another factor to consider is the added stress of having to make two mortgage payments while accruing interest on a bridge loan. This can become increasingly difficult to bear — financially as well as mentally — if the home you are trying to sell isn’t getting any offers. “If you do decide to take out a bridge loan, be aware you’re going to accrue a significant amount of new debt, and may wind up having to pay back multiple loans if your home doesn’t sell quickly,” Wichter warns.
The bottom line
Generally, homeowners are better off waiting on the sale of their current home before buying the new one. That said, in tight circumstances, bridge loans may prove not just advantageous but necessary. Before you take out a bridge loan, consult a financial advisor at your local institution and explore alternative options such as home equity loans or personal loans.