Bridge Loans: How They Work, Pros, and Cons

Bridge loans help you unlock the equity in your current home in order to make a competitive cash offer on a new property before you sell your first home. A bridge loan is a powerful financing option that can give you an advantage in hot markets and make it easier to buy a new home without worrying about the timing of selling the first. But it also comes with significant costs and risks you need to be aware of before you commit.

We’ll cover what bridge loans are, how they work, how to qualify, when they do and don’t make sense, their pros and cons, and some alternatives you may want to consider.

What are bridge loans?

A bridge loan is a short-term loan that bridges the financial gap between buying a new home and selling your current one. In traditional home sales, you fund the purchase of your new home with the sale of your old one. A bridge loan enables you to buy before you sell by tapping into the equity of your current home and then paying off the bridge loan once you sell your first home.

Bridge loans are a type of mortgage, meaning they use your house as collateral. They have a short term, typically around 6-12 months, during which you’ll often only make interest payments[1]. You’d typically be expected to pay back the bridge loan using the proceeds from the sale of your old house.

When does a bridge loan make sense?

A bridge loan makes sense if you live in a hot buyer’s market where you can be reasonably sure that your home will sell within 6-12 months. A bridge loan frees you up to make a non-contingent offer on another property. Since you know your current home will sell, bridge loans come with relatively short-term costs and give you a competitive advantage against other buyers.

Similarly, a bridge loan can be helpful if you’ve found your dream home and don’t want to risk missing out on it while you wait for your current house to sell. Plus, it can help you avoid the need for temporary housing that sometimes arises between selling your old home and buying another one.

However, be aware of the risks associated with bridge loans and understand what you need to buy a house so you’re better prepared. If you live in a slow market, a bridge loan could leave you stuck with having to pay for two mortgages while you wait for your old home to sell.

They also are risky if your previous home needs renovations before it can be listed. Bridge loans tend to have high interest rates, so waiting months before selling means you’ll be paying interest costs and potentially losing out on benefiting from any increased value renovations would otherwise bring.

If you’re simply looking to tap into your home’s equity to fund repairs, a second home mortgage may provide a lower interest option.

How do bridge loans work?

Bridge loans can provide funding in as little as two weeks from when you first apply[2]. The process can be broken down into three sections:

• Application process: The lender will often require an appraisal of your current home to determine the maximum bridge loan you’ll qualify for. You’ll also need to provide other documentation, such as mortgage statements, proof of income, credit reports, and bank statements.
• Loan period: While you attempt to sell your old home, you’ll make interest-only payments. You’ll typically have a given amount of time — often 6-12 months — of interest-only payments. However, keep in mind that during this period you may have a mortgage on your new home that you’ll also be paying.
• Payoff process: Once your old home sells, you’ll use the sale proceeds to pay off the bridge loan. You may also have to cover closing costs, such as origination fees, related to the loan.

Who qualifies for a bridge loan?

Bridge loan requirements are similar to traditional home loan requirements. Lenders typically want to see a minimum credit score of 680 to 700 and at least 20% equity in your home. They’ll also need to verify you have the ability to maintain two properties at once temporarily and they’ll use your new mortgage payments in calculating your debt-to-income ratio (DTI).

Who offers bridge loans?

Bridge loans can be obtained from a variety of lenders, such as:

• Traditional banks and credit unions have more stringent requirements and may only lend to existing customers, but if you qualify they may offer better rates.
• Portfolio and private lenders offer more flexible qualifications and a faster approval process, but their rates and fees are usually higher.
• Online lenders, such as Homeward and Knock, have a streamlined application process and competitive rates, but service quality and fees vary substantially so you’ll need to do your research to make sure you’re getting the best deal.

Our recommendation is to shop multiple lenders and compare the total costs. While some lenders may advertise low interest rates, you want to make sure fees and closing costs don’t end up costing you more in the long run.

Pros and cons of bridge loans

Bridge loans have a number of advantages, especially in competitive markets. But there are also some very serious disadvantages and risks you’ll need to be aware of

Understand the risks of bridge loans

If you’re considering taking out a bridge loan, it’s important to understand the risks, especially if you’re already facing financial struggles. The primary one is that if your current home doesn’t sell in time, you’ll need to refinance or extend your bridge loan. Either option is expensive and if you’re unable to pay you risk foreclosure and substantial damage to your credit score.

Even if you don’t default, carrying costs on two properties is a heavy financial burden and it may force you into accepting a lower selling price. Also, be aware that the real estate market can shift suddenly, so even if a bridge loan seems low risk today, there’s no guarantee that it will stay that way within a few months, which could leave you struggling to sell your home.

Bridge loan alternatives

Buy-before-you-sell companies

Buy-before you-sell companies, such as Calque, UpEquity, and Flyhomes, are similar to — and in many ways a type of — bridge loan program. Often the main difference is that the company tends to be more directly involved. For example, they may purchase your property on your behalf, allowing you to avoid having to manage two homes at once.

However, buy-before-you-sell companies often charge high service fees and they may be limited to specific markets or geographic areas. Depending on your credit history and financial circumstances, they may also offer less flexibility than bridge loans.

Home equity line of credit (HELOC)

A HELOC is a revolving line of credit that you can draw upon as needed, similar to a credit card but with your home used as collateral. They’re a good option if you just need smaller amounts of credit or have significant equity.

They typically have longer draw periods than bridge loans (around 5-10 years) and more flexible repayment options. You also only pay interest on the amount used and the fees are lower.

However, unlike bridge loans, HELOC lenders consider your entire credit line when calculating your DTI ratio, not just the drawn amount. This can reduce your borrowing capacity for a new mortgage and it may disqualify you from qualifying for financing a new home purchase.

Home equity loan

A home equity loan is similar to a HELOC, but it provides a lump sum rather than a revolving credit line. Home equity loans often offer fixed interest rates and longer repayment terms than bridge loans, plus lower rates.

However, you’ll be making full monthly payments immediately based on the entire loan amount, not just the amount you need (like with a HELOC). And like a HELOC, a home equity loan has a much bigger impact on your DTI ratio than a bridge loan does, which can make it harder for you to qualify for the full amount of financing you may need for a home purchase.

Cash offer companies/iBuyers

If your priority is a fast sale, cash home buyers and iBuyers can close in as little as two weeks. While they don’t usually provide bridge loans or financing, they offer some similar advantages. Since their cash offers are nearly guaranteed, you can more easily coordinate the purchase and sale of your properties without risking the need for temporary housing or having to rush to find a buyer.

However, cash buyers offer significantly less than market value and iBuyers charge service fees that can be as high as 5%. Plus, you’ll have limited ability to negotiate on price and terms, although they tend to be flexible with closing dates.

Start with a great real estate agent

Working with a real estate agent is usually the best option for making the most from your sale while understanding all of your buying and selling options. Your agent can help you get your house ready for listing so it sells quickly and for a competitive price.

If you’re concerned about timing, realtors can offer strategies to buy and sell within your timeframe. They can assist with coordinating both transactions so you don’t have to worry about temporary housing or carrying two mortgages.

While traditional real estate agents can charge up to 2.5-3%, by working with a company like Clever you can list for just 1.5% while still getting assistance from a top local realtor. Try Clever today and get started.