How Do Bridge Loans Work?

by | Jun 26, 2022

A bridge loan can help you avoid an unenviable real estate situation: you want to buy a new home, but need your current home to sell before you can afford the down payment. Because a bridge loan is designed to bridge that gap, it offers you flexibility as you navigate the real estate market. Read on to learn how bridge loans work, the pros and cons, and how to know if one of these loans is right for you.

What Are Bridge Loans?

Bridge loans serve as short-term financing when you need immediate cash flow but can’t make an asset liquid yet. People use bridge loans during real estate transactions when they need to sell their current home to afford the down payment on a new one. For this reason, these loans usually have six- to 12-month terms. A bridge loan gets you the cash necessary to offer that down payment without needing to wait for your current home to sell.

In the ideal scenario, you’d sell your current home, pay off your mortgage, and have cash left over for a down payment on a new home. However, sometimes you need to make an offer on a new house before your current home sells. This is especially common when people are changing jobs or need to move quickly. Some buyers put in offers on a new home that are contingent on their current home selling. If you do this, the seller may not accept your offer if someone else has the down payment ready.

Companies can also get commercial loans to serve as bridge loans, acting as temporary capital until a permanent source of funding comes through or until a debt is cleared. Individuals typically only secure bridge loans for real estate transactions because their current home becomes collateral.

How Do Bridge Loans Work?

Lenders typically offer two borrowing choices for a bridge loan. The first option is similar to getting a second mortgage. Lenders will calculate the difference between the amount you owe on your current mortgage and 80% of your home’s value. That difference is the highest amount you can borrow for a bridge loan, however, you need only borrow the amount you require for a down payment on a new home. The amount you borrow is separate from your original mortgage and from the new mortgage you’ll get when you purchase a new house.

The second choice is to get a bridge loan large enough to cover your down payment and pay off your original mortgage. You borrow more upfront, but you don’t have two loans like in the first scenario. Once you sell your home, you can apply those funds toward the bridge loan instead of to your original mortgage. How you repay the loan will vary slightly based on lenders, but the typical strategy is to use money from the sale of your home to pay off the loan. 

How Do You Get a Bridge Loan?

To qualify for a bridge loan, you need to have equity in your current house. Potential lenders will look at your debt-to-income ratio and your credit score. They may also look at your income and whether you were late on any payments for your current mortgage. For people who are well-qualified, the process can go faster than getting a traditional mortgage. If you don’t have much equity in your current home, it can be harder to qualify. Be sure to inquire at banks, credit unions, and private lenders.

What Are the Benefits of Bridge Loans?

If you’re in a seller’s market, a bridge loan allows you to make a down payment on a home right away, meaning you won’t have to put a contingency on your offer. When you need to move quickly, such as for a new job, you won’t have to wait for your old home to sell. If your old home sells faster than anticipated, you may need to live somewhere temporarily before you can move into your new home, and a bridge loan can help with the costs.

What Are the Drawbacks of Bridge Loans?

This type of loan usually has a higher interest rate than a traditional mortgage, and you’ll also incur closing costs and origination fees. While lenders may allow you to defer payments or make interest-only payments until your house sells, you’ve still taken on extra debt. Additionally, you take the risk that your house might not sell during the time frame of the loan, which in extreme cases can lead to foreclosure. Whether or not your house sells, you’re responsible for paying the loan back at the end of the term.

When Should You Consider a Bridge Loan?

If you have equity in your current home and need cash quickly, a bridge loan may be the right choice for you. With the proper financial leeway to take on the extra costs associated with this type of loan, you can still get the new house you want if that seller won’t take a contingency offer. One can also help you avoid mortgage insurance by allowing you to put down at least 20% on your new home. These loans are a good choice if you’re in a seller’s market and your current home may sell soon.

Now that you understand bridge loans, the best way to discover if one is right for you is to get in contact with a Quick Lending loan officer. We’ll ask about your financial history, discuss your home-buying needs, and determine your eligibility. At Quick Lending, we’re a customer-focused hard money lender with the goal of getting you the cash you need with as little difficulty as possible. We offer competitive rates on bridge loans and pride ourselves in our flexibility and meeting customer needs. Contact us today so we can help you secure a bridge loan.