What Is a Bridge Loan?

If you’re trying to buy a new home before selling your current one and want to avoid a sale contingency, a bridge loan could be a good alternative. However, this financial product can be a bit risky if you don’t fully understand how it works. 

Learn all about bridge loans, including their pros and cons, so you can decide whether it makes sense for your financial situation. 

What is a bridge loan?

A bridge loan is a short-term loan designed to bridge the gap when you want to buy a new home but haven’t sold your current one yet. 

Many homeowners need to use the equity from their current property to purchase the next. To get enough funds for a down payment and closing costs, they might ask for a sale contingency. However, some sellers will reject offers with this contingency.

Bridge loans are an alternative. They allow you to access cash quickly based on your current home’s equity. You can use this money to cover closing costs and make a down payment on a new home. These loans are designed to be temporary. Borrowers pay them off after they sell their previous homes.

How does a bridge loan work?

A bridge loan uses the equity in your current home as collateral. A lender will typically allow you to borrow a percentage of that equity, usually up to 80%, minus what you still owe on your mortgage. Here’s how it works:

• You apply for a bridge loan
• The lender evaluates how much equity you have in the home
• The lender reviews your income and credit profile
• If you’re approved, you receive funds to use toward your new home purchase
• You repay the loan when your existing home sells

The lender may issue funds to you as a lump sum or a line of credit. With the lump sum structure, you receive a single payment to use to purchase the new home. If you are approved for a line of credit, you can draw funds as needed, up to the cap. 

What is a bridge loan repayment term? Typically, it’s six to twelve months. During that time, you might make interest-only payments, or you might be able to defer payments until your home sells. 

Interest rates on bridge loans are usually higher than traditional mortgages because of their short-term nature. 

When does a bridge loan make sense?

Bridge loans can be risky if used in the wrong situation. However, you may want to consider a bridge loan if:

• You’ve found your dream home, but your current property hasn’t sold yet
• You have plenty of equity in your current house
• You need funds for a down payment
• Sale contingency offers are frequently rejected in your market
• Your current home is likely to sell quickly

The danger arises when your existing home sits too long. In this scenario, your bridge loan could come due before you have the money to repay what you borrowed. Even if the lender offers an extension, you could rack up thousands of dollars in interest. 

Pros and cons of a bridge loan

There are benefits and drawbacks to a bridge loan. Comparing the good and bad of this financial product will help you make an informed decision. 

Pros

The pros of a bridge loan include:

• You can buy a home before you sell your current one
• Your offer will be stronger than similar offers with sale contingencies
• You can use your home equity for a down payment and closing costs 
• There is less pressure during the transition to the new home

Since sale contingencies mean that there is a greater chance the deal could fall through or get delayed, these offers are less likely to be accepted by home sellers. With a bridge loan, you can make a stronger offer while you wait for your existing residence to sell. 

Cons

There are some downsides to a bridge loan, including:

• You’ll pay higher interest rates, raising your overall costs
• Bridge loans include origination fees and other costs 
• You’ll be carrying two or three loans at once
• If your property doesn’t sell quickly, you can end up in a difficult financial situation

In some markets, a bridge loan can be very risky. Evaluate your local market and gather feedback from a real estate professional. You need your current home to sell rather quickly so you can minimize your interest payments and avoid juggling two or three loans for a long period.  

Alternatives to a bridge loan

If a bridge loan feels too risky or expensive, you can consider these options:

• Home Equity Line of Credit: Lets you borrow against your home’s equity
• Home Equity Loan: A lump-sum loan with fixed payments 
• Contingent Offer: Less competitive, but also less risky
• Selling Your Home First: Requires you to move temporarily during your home search

There aren’t any right or wrong answers. It’s all about finding which approach is best for you. 

Conclusion

Whether you decide to apply for a bridge loan or explore other financial products, you need a strong credit score. Kikoff is a credit-building platform that includes free and paid tools to help you strengthen your score. With a stronger profile, you can increase your approval odds and unlock more competitive rates.

Start building a positive credit history with Kikoff.