Nicole Mazzola

858.775.0328
nicole@aare.org

1020 Prospect Street #350
La Jolla, CA 92037

What Are Bridge Loans and How Do They Work?

May 19, 2017

what-are-bridge-loans-and-how-do-they-work

If you’ve bought a new home that closes before your current home does, you may be stuck with the responsibility of paying for two homes for a brief period of time. As daunting as that might sound, you may be able to arrange for a bridge loan to help alleviate this financial burden.

Like the name suggests, a bridge loan bridges the gap between closings and is taken out against your current property to finance the purchase of your new home. Also known as “swing loans” or “gap financing,” these short-term home loans provide cash flow right away to help you meet your financial obligations while you’re setting up long-term financing for your new home. That way you’re not left carrying more of a financial load than you’re comfortable with.

Bridge loans can also be used for multi-family or commercial properties when funding is needed to complete the sale of a current property while meeting the requirements of another mortgage. Like a standard single family home, multi-family and commercial properties also need collateral to back a bridge loan.

How Does a Bridge Loan Work?

Before a lender approves a borrower for a bridge loan, a minimum credit score or debt-to-income ratio may need to be met. However, there aren’t any specific guidelines associated with these types of loans. Instead, they’re typically dependent on the long-term financing that’s being secured.

Bridge loan lenders may be more willing to accept a higher debt-to-income ratio if your new home loan is with a traditional lender at a standard interest rate. However, if you’re taking out a jumbo loan for your new mortgage – which is a home loan amount that exceeds the conforming loan limit of $417,000 – the lender will likely put a limit on the debt-to-income ratio.

Bridge loans can be arranged so that they pay off the entire existing home loan on a current property. In this case, the bridge loan will pay off any and all existing liens and use whatever money is left over to be put towards a down payment for the new property. Instead of making monthly payments on your bridge loan, you’ll be making mortgage payments on your new home. After the house sells, the proceeds of the sale will be used to pay off the bridge loan, as well as any associated interest.

A bridge loan can also be structured as a second home loan that is paid on top of the existing loan. In this case, the bridge loan is taken out as a second (or even third) mortgage and is used only as a down payment towards your new home. You will still be required to make your old mortgage payments and the new mortgage on your new house, which can be pretty expensive and put you in a tough situation if your finances can’t adequately handle all these payments.

Benefits of Bridge Loans

Perhaps the biggest benefit of a bridge loan is the fact that you can buy another home with minimal restrictions while putting your current home up for sale at the same time. Rather than being stuck paying for two mortgages, you’ll have the advantage of not making any monthly payments towards the bridge loan for a few months. In addition, if you insert a contingency in your offer on a new home and the seller issues a Notice to Perform, you can waive the contingency to sell your home and still go ahead with your purchase.

Costs Associated With Bridge Loans

While bridge loans can be convenient, they’re not without cost. In fact, bridge loans often come with a steep price tag. Before you consider taking out a bridge loan, consider all the expenses associated with them, including the following:

  • Administration fees
  • Appraisal fee
  • Escrow fee
  • Title policy fee
  • Legal fees
  • Recording fee
  • Loan origination fee

The interest rates associated with bridge loans, in particular, should be carefully looked at before going ahead with a bridge loan. These rates are typically higher than the average posted rate, usually around 2% more. However, the rates will depend on things such as your credit score and the current prime rate.

There’s also a risk of your current property not selling within the life of the bridge loan. On the other hand, if your home sells before the bridge loan expires, you could be slapped with prepayment penalties if you pay the off the loan too early.

The Bottom Line

Before you decide to go the bridge loan route, make sure you do your homework on them first. Check out what the typical asking prices are in the neighborhood and how long homes are typically taking to sell. If the market is a strong one, you might not need to take out a bridge loan. However, if you think you need one, work with your lender to ensure you’re provided with terms on both your bridge loan and long-term home loan that you’re comfortable with and that meet your needs.