What is a Bridge Loan and
How to Use it to Buy a House
Buying a new home before selling your old one can create a problem – a cash gap. A bridge loan can close that gap. Let’s look at the uses, benefits, potential drawbacks, and alternatives to bridge loans.
Bridge Loans 101
Sometimes called a gap loan or a swing loan, a bridge loan “bridges” the gap between selling and buying. It solves a common homebuying problem: you’ve found the home you want but haven’t yet sold your current one.
Typically lasting six to 18 months, bridge loans give you time by providing access to your home’s equity – in cash – before it’s sold. Usually, your current home serves as collateral, but other assets, including the new home, can help secure the loan.
When do you repay a bridge loan?
Many borrowers pay off a bridge loan immediately after selling their current home. However, you have until the loan’s term ends to pay the balance. Borrowers usually make payments in one of two ways:
- Regular installments. You gradually repay principal and interest over the loan term. This type of repayment typically leaves a smaller balance at the end compared to the alternative method.
- Balloon payments. Here, borrowers repay mostly interest over the loan term. Then they pay off the full lump sum before or at the end of the loan term.
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How much can you borrow with a bridge loan?
Bridge loans range from tens of thousands of dollars to over $1 million. The amount you can borrow usually depends on the equity in your current home. A mortgage professional may allow you to borrow up to 80% of your home’s value, less what’s owed on the mortgage.
Say, for example, your house is worth $400,000 and you owe $200,000 on your mortgage. 80% of the home’s value is $320,000. Subtracting the $200,000 owed leaves a maximum borrowable amount of $120,000.
When are bridge loans most useful?
Here are some common scenarios where bridge loans are especially effective:
- Eliminating contingencies. A home sale contingency is for buyers who need to make buying their new home dependent on selling their current home. Home sellers often dislike this uncertainty, preferring a non-contingent buyer with cash in hand. A bridge loan can help make you the preferred buyer.
- Closing dates don’t align. This is a common situation: a buyer has made two deals – to buy a new home and sell an existing one. The closing date for the new home, however, comes first. A bridge loan can provide the short-term cash needed during that gap.
- Down payment. Homeowners can use the equity in their current home to access cash for the down payment on their next home.
- Real estate investing. House flippers often rely on bridge loans. For investors who buy, improve, and sell properties within a few months, bridge loans can be perfectly structured.
How can you use a bridge loan when buying a home?
Fast and flexible, bridge loans meet several homebuying circumstances. These include:
- Buying first, then selling. Advantageous in a competitive market, a bridge loan can give homebuyers the power to make a non-contingent offer on a new home before selling their old home.
- Selling first, then buying. The gap between accepting an offer on your old home and getting cash in hand from the sale is typically between 30 and 60 days. With a bridge loan, you have access to cash during that in-between period.
- Upfront costs. Most homebuyers pay closing costs – usually from 2% to 5% of the loan amount – in cash. You may also use a bridge loan to pay home inspection fees, an earnest money deposit, Homeowners Association (HOA) fees, or make a Private Mortgage Insurance (PMI) payment.
- Mortgage payoffs. Some homeowners pay off their old mortgages with bridge loans. In this scenario, it’s common for the old home and the new home to serve as collateral.
- Home renovations. Are you buying a home that will need work before it’s move-in ready? A bridge loan can help.
Pros & Cons of a Bridge Loan
Pros
- Fast funding. In many cases, bridge loan approval and funding take just a few weeks – delivering cash on time at a critical phase in the homebuying process.
- Purchasing power. From the seller’s perspective, non-contingent offers are usually stronger than those with home sale contingencies.
- Flexible repayment. Having options such as deferred or interest-only payments during the loan term can ease short-term cash flow.
- More time to sell. A bridge loan can eliminate the pressure to make a rushed sale on your current home to finance your next home.
Cons
- Higher costs. Because they are considered riskier, bridge loans often have higher interest rates compared to other loan types and come with significant fees and closing costs.
- Qualification. While not as rigid as some higher-value loan types, the approval process for bridge loans often has stricter credit and documentation requirements compared to conventional mortgages.
- Overleveraging risk. Overestimating your home sale price or underestimating housing market conditions could lead to more debt than is manageable.
Alternatives to Bridge Loans
- Home Equity Loan: Allows you to borrow against your home’s equity, usually with lower fixed interest rates than a bridge loan. A home equity loan may work best for homebuyers who have time to wait for approval – typically 30 to 45 days.
- Home Equity Line of Credit (HELOC): Provides flexible access to funds as needed, with interest-only payments during the draw period – commonly up to ten years. A home equity line of credit could be ideal when you’re unsure of the exact timing or the amounts you’ll need.
- 401(k) Loan: Lets you borrow from your retirement savings, often at a lower cost than a bridge loan, with no credit check required. You typically have five years to repay.
At their best, bridge loans provide breathing room – giving you space to navigate buying and selling without feeling rushed. To talk about whether a bridge loan might be right for you, reach out to an Equinox mortgage expert at 1-888-505-8960 or connect with us online.