A “bridge loan” is a short-term loan taken out by a borrower against their current property to finance the purchase of a new property. Also known as a swing loan, gap financing, or interim financing, a bridge loan is typically good for a six month period, but can extend up to 12 months.
Bridge loans are generally taken out when a borrower is looking to upgrade to a bigger home or downsize, and haven’t yet sold their current home. A bridge loan essentially “bridges the gap” between the time the old property is sold and the new property is purchased.
Home Buying Contingencies.
Many purchase contracts have contingencies that allow the buyer to agree to the terms only if certain actions occur. For example, a buyer may not have to go through with the purchase of the new home they are in contract for unless they’re able to sell their old home first. This gives the buyer protection in the event no one buys their home, or if nobody is willing to buy the property at the terms they desire.
When a seller won’t accept the buyer’s contingency, a bridge loan might be the next best way to finance the new home.
How Do Bridge Loans Work?
A bridge loan is cross collateralizing the property that is being purchased with the old property. Often, the entire purchase price can be made with a Bridge Loan and the buyer does not have to make an additional down payment (if the combined equity is below 70% minus existing mortgages).
And once your old house sells, you’ll use the proceeds to pay off the bridge loan, including the associated interest and remaining balance. You’ll still need to make payments on your old mortgage(s), so make sure you’re able to take on such payments for up to a year if necessary.
Most consumers don’t use bridge loans because they aren’t necessary during housing booms and hot markets. For example, if your home goes on the market and sells within a month, it’s typically not necessary to take out a bridge loan. But now that things have cooled off, they may become a bit more common as sellers experience more difficulty in unloading their homes.
Bridge Loans Can Be Risky
Many critics find bridge loans to be risky, as the borrower essentially takes on a new loan with a higher interest rate and no guarantee the old property will sell within the allotted life of the bridge loan. However, borrowers usually don’t need to pay interest in remaining months if their home is sold before the term of the bridge loan is complete. But watch out for prepayment penalties that hit you if you pay the loan off too early!
Make sure you do plenty of research before selling your home to see what asking prices are and how long homes are generally listed before they’re ultimately sold. The market may be strong enough so that you don’t need a bridge loan. But if you do need one, be aware that a home could go unsold for six months, or longer, so negotiate terms that allow for an extension to the bridge loan if necessary.
If you think a bridge loan is right for you, try to work out a deal with a single lender that provides both your bridge loan and long-term mortgage. Usually they’ll give you a better deal, and a safety net as opposed to going with two different banks or lenders.