What is a Bridge Loan? A Creative Homebuying Solution

DISCLAIMER: As a friendly reminder, this post is meant to answer the question, “What is a bridge loan?” and is intended for educational purposes, not financial advice. If you need assistance navigating the use of a bridge loan, HomeLight always encourages you to reach out to your own advisor.

So you’ve been house-hunting a bit prematurely and fell in love with your dream home — but wait, don’t you have to sell your old home first? Not always!

Selling your old home and buying your new one can mean a tricky balance of timing and funds, but a bridge loan might be the solution you are looking for to help the pieces fit together. Bridge loans are short-term financing solutions that help homeowners purchase a new home before selling their old one.

To give you all the information you need to evaluate if a bridge loan is right for you, we spoke with Rick Ruiz, who sells homes 67% faster than other agents in the Las Vegas, Nevada area, and Heidi Daunt, Branch Manager and owner of Treehouse Mortgage Group with over 35 years of lending experience. Let’s dive in.

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What is a bridge loan, in simple words?

When it comes to real estate, a bridge loan (sometimes known as a swing loan or bridging loan) is a short-term loan to help homeowners during the transition of buying a new home while selling their current home. These loans will use the equity in the buyer’s current home to give them the cash to make a down payment and cover closing costs on their new purchase.

Typically more expensive than traditional mortgages, bridge loans are intended to be a convenient and fast way to make your new purchase without waiting for your old home to sell.

How does a bridge loan work?

As a homeowner, the most common reason you would apply for a bridge loan is if you want to buy a new home before your existing home has sold. In this situation, you’ll typically use the equity from your current property to cover the down payment and closing costs for your new purchase.

In many cases, the lender providing your new mortgage will also handle your bridge loan. Lenders typically require that your previous home be listed on the market, and will offer the bridge loan for a maximum of six months to one full year.

“There’s actually a lot of companies now that do this — and they’re growing by the day — that are willing to lend you the money knowing that you’re going to be selling your home and they’ll be able to get paid in full in a reasonably short amount of time,” Ruiz shares.

Depending on your unique situation, the lender on the new home might need to calculate your debt-to-income ratio (DTI). The DTI equation would include the payments from your current mortgage on your old house, your new payment on the home you are purchasing, and the interest-only payment on the bridge loan (if applicable). However, your lender might be able to only include your new mortgage payment if your previous home is under contract and the new buyer has final loan approval for their purchase.

Lenders do this to ensure that you will be able to make the payments on both properties in the event that your home does not sell immediately.

What are the benefits of a bridge loan?

For the savvy homeowner, bridge loans can be a great tool for closing the gap between buying a new home and selling your old one. Here are some of the benefits of this kind of financing:

You can make a non-contingent offer on your new home

With such high demand in the market brought on by a housing shortage, many sellers still receive multiple offers for their homes even as the market has cooled in 2022 and early 2023. As such, an offer that is contingent on the buyer selling their old home is not as appealing to sellers who might have other non-contingent offers.

“When you are making an offer that is contingent on the sale of your previous residence, which is the alternative to getting a bridge loan, you don’t have a lot of purchase price negotiation ability because you are asking the seller to wait until you sell your home. If you have an approved bridge loan, you can write a non-contingent offer, so it gives you better negotiating power on your new purchase,” Daunt explains.

You only have to move once

One of the biggest stressors for homeowners who want to buy and sell at the same time is the timing. If you sell your home first, and can’t close on your new home in time, you risk having to find a temporary place to live.

While this is not only inconvenient, it can be expensive. The average cost for a full-service move is $9,060, according to Move.org — yikes. Paying movers to move all of your belongings from your old home to your temporary one, then finally to your new purchase, would double that expense. Temporary housing solutions (especially furnished short-term rentals if you’d prefer to leave your belongings in storage) are also expensive. A bridge loan could be your solution to this problem.

Some lenders don’t require payments during the loan period

Repayment options will vary depending on the lender, but many will not require you to make a monthly payment on your bridge loan during the loan period. Some lenders might require an interest-only monthly payment or a lump sum interest payment at the end of the term along with the loan balance.

This can make a bridge loan a convenient option for buyers who are tight on cash before selling their previous home, allowing them to pay off their bridge loan using the proceeds from their sale.

What are the drawbacks of a bridge loan?

There are a number of factors to weigh before you commit to bridge loan financing. Always read the fine print and evaluate all costs and terms with a trusted loan advisor before making a decision. Here are some of the drawbacks of bridge loans:

The cost

When adding up all of the expenses of buying and selling a home, the cost of a bridge loan, on top of everything else, can seem daunting. However, you are paying for the convenience and ease that a bridge loan provides — and it comes at a premium.

Daunt shares that with the bridge loans she offers at Treehouse Mortgage Group, this fee comes out to 2% of the bridge loan amount. Other lenders might charge more or less for this kind of loan, but 2% is typical. So, for a bridge loan of $200,000 to put toward your down payment on your new purchase, this would be a cost of $4,000.

Interest rates for bridge loans are also typically higher than those for traditional mortgages, due to the short-term nature of these loans.

They can be difficult to qualify for

Your lender will need to evaluate all of your monthly payments to determine if you can afford your mortgage payment for your new home purchase. And unfortunately, they might need to factor in your payment on your departing residence if it has yet to be sold or is not under contract to be sold.

Unless you have sufficient monthly income to cover both mortgage payments according to your specific lender’s guidelines, you might not qualify for this kind of financing. However, these policies are in place to protect both the lender and you as the consumer to avoid getting stuck with two payments that you might not be able to afford.

In addition to your monthly income, lenders will also review the amount of equity you have in your departing residence to determine how much you are qualified to borrow. If you owe more than 80% of your current home’s value, you might not qualify.

When might I need a bridge loan?

While bridge loans are not a new thing, they are not as common as other loans. “A lot of people don’t even know that there are bridge loans available… or they have heard of them but they don’t understand them and can’t find a professional who actually offers them,” shares Daunt.

Some examples of when a bridge loan might be a solution include:

• You won’t have money for a down payment until you sell your current home, aka your equity is tied up in your house.
• You only want to move once — instead of selling your home right away before you buy your new one, you want to buy first and move directly from your previous home to your new one (and save on time and hassle).
• You’ve selected a new home and don’t want to risk losing it to another buyer. In more competitive markets, you may need to act quickly.
• You aren’t able to close the sale of your existing home before closing on your new home
• You’ve made an offer, but the seller won’t accept a home sale contingency.
• As an investor, you need to quickly take advantage of a fix-and-flip opportunity. “A bridge loan is a very common way for an investor to temporarily get the property financed — and then, of course, this gives them time to rehab the property, get it on the market, and sell it,” shares Ruiz.

What’s required to get a bridge loan?

Lender qualifications will depend on the lender you choose and your unique situation — bridge loans are not a one-size-fits-all solution. However, most lenders will evaluate the value of your current home compared to your current mortgage payment, the value of the home you would like to purchase, your credit score, your income, your monthly debt payments, and your assets at a minimum.

To qualify for a bridge loan, you typically need:

• Qualifying income: Your lender will evaluate your income streams to determine if you can afford to make the payments on your current mortgage, your new mortgage, and possibly an interest-only payment on your bridge loan.
• Sufficient existing equity: You should have at least 20% equity in your current house, although some lenders will require up to 50% equity.
• Good credit history: Depending on the lender or bridge loan program, you will need a favorable credit score, typically above 650. Your score will likely influence your interest rate and other qualifications, such as loan-to-value ratio, so the higher the better.
• Your current home to be listed for sale: This is not always the case, but some lenders might require proof that your current home is on the market to make sure it will be sold by the end of the bridge loan term.

How much does a bridge loan cost?

As noted above, bridge loans are not cheap. A 2% premium is common for this kind of financing, but it varies widely between lenders. If you are applying for a bridge loan with the same lender as with your new mortgage, you won’t likely need to pay for extra underwriting or other mortgage fees as your bridge loan and new mortgage will be underwritten and approved at the same time.

Interest rates for bridge loans are typically higher than those for traditional mortgages, however. Your rate will likely depend on your creditworthiness and the type of lender, but as of early 2023, Daunt shared the current going rate at her company of 6.99% (with a traditional bank), while Ruiz shared an estimate of between 10% and 12% (with private money). Compared with the current average 30-year fixed mortgage rate (March 2023) of 6.6%, bridge loans can be significantly more expensive.

Who provides bridge loans?

Not all lenders are created equal — some institutions will be more focused on residential lending, while others will be a better choice for investors and businesses. Here are the most common sources for bridge loans:

• Local banks
• Credit unions
• Hard-money lenders (also known as private money lenders)
• Non-qualified mortgage (non-QM) lenders

Are there alternatives to bridge loans?

While a bridge loan might not work for every homeowner’s unique situation, there are alternatives to consider:

• Home equity loan: This kind of loan lets a homeowner take their existing equity out of their home’s value in the form of a lump sum payment. Interest rates for a home equity loan can be more expensive than your current rate on your first mortgage, but instead of completing a cash-out refinance for, say, $400,000 at 5% (paying off the first mortgage and borrowing cash), you can just borrow the $100,000 you need at a 6% interest rate and leave your first mortgage of $300,000 at its lower rate of 3%.
• Home equity line of credit (HELOC): Another option for homeowners to use their existing equity in their current home, HELOCs allow a borrower to pull money out of their property for a relatively low interest rate. Instead of receiving the money all at once, your lender will extend a line of credit for you to borrow against. You might, however, have to pay an early closure fee if you open this line of credit and close it very soon after, according to Daunt.
• Cash-out refinance: This type of loan lets borrowers pull cash out of their home, while refinancing their previous mortgage at the same time. Interest rates are typically higher for these kinds of loans compared to regular refinances, but are lower than those for bridge loans. This is not a solution for everyone, though — “you cannot do two owner-occupied loans within one year of one another,” according to Daunt. This would mean that you might have to wait longer to finance your new purchase with an owner-occupied mortgage using the cash from your cash-out refinance.
• 80-10-10 (piggyback) loan: This option is called a piggyback loan because you would be taking a first mortgage and second mortgage out at the same time to fund your new purchase — this means that you would only need 10% down. For buyers who can’t make as large of a down payment before selling their previous home, this could be a solution that helps them avoid the cost of mortgage insurance. You would, however, still be carrying the cost of three mortgage payments until you sell your current home and can pay off the second mortgage.
• A 401k loan: Borrowing against your retirement account comes with some benefits and drawbacks — your repayment period will be relatively short (up to 5 years) and your monthly payment will likely be high. This could affect your ability to qualify for your new mortgage, as your lender will need to include this monthly payment when calculating your debt-to-income ratio. If your 401k plan allows, you might be able to borrow up to $50,000 to put toward your new purchase.

Are there companies that can help me buy a house before I sell?

In today’s market, there are companies like HomeLight that provide solutions for homeowners stuck in the tricky situation of needing to buy a home before they sell their old one. These companies incorporate bridge loans to close the gap between your two homes to take much of the stress out of moving.

HomeLight’s Buy Before You Sell program, available in Arizona, California, Colorado, and Florida, does just that. This program allows you to purchase your new home and move in, while getting assistance to sell your old home. Examples of other “buy before you sell” or home trade-in service companies include Knock Home Swap, Orchard, and Ribbon.

The final word on bridge loans

Bridge loans are a creative solution for homeowners that need to purchase their next home quickly, before they are able to sell their old one. Using the equity from your current home, you can purchase your new property with a bridge loan for your down payment and pay it off once you sell, taking the hassle out of buying and selling at the same time. While this kind of financing can be an extremely convenient way for homeowners to do this, it can be costly and may not work for everyone.

Consider HomeLight’s Buy Before You Sell program to take the uncertainty out of your next home purchase — and while you’re at it, HomeLight also offers other solutions for simplifying your real estate journey, such as Agent Match to find the top-performing real estate agents in your market (for free!), and Simple Sale, which can provide you with a no-obligation cash offer for your home and close in as little as 10 days.

Source: (elenathewise / Depositphotos)

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