Bridge Loan

Bridge Loan

A bridge loan, which is also sometimes referred to as a swing loan, is a short term loan that is used by a borrower who has not sold their current home, to help them purchase a new home. An individual who has found their new "dream home" before they have sold their old home, or worse yet, before they have even put their old home on the market, has a few options available to them to purchase the new home, including:

  • Making a contingent offer on the new house. The vast majority of home sellers will probably reject an offer with a home sale contingency.
  • Borrowing from family or friends.
  • Borrowing from retirement accounts.

Assuming that these options are not available to the borrower, the bridge loan can be an attractive alternative to obtain that dream home. There are two basic types of bridge loans:

  1. A bridge loan that pays off the existing mortgage and gives the borrower money to make the down payment on the new loan. Typically, with this type of loan the borrower is not required to make monthly payments. When the first home sells the borrower pays off the bridge loan along with accrued interest. With this option, the borrower has only one monthly mortgage payment, the payment on the new home's mortgage. If it takes a long time to sell the home the bridge loan may require interest only payments at some point in time, typically after six months.
  2. A bridge loan that borrows against the equity in the first home to provide the down payment for the second. As with the first type of bridge loan, borrowers typically do not have to make monthly payments on the bridge loan, simply paying it off with accrued interest when the house sells. Unlike the first scenario, however, with this type of bridge loan the borrower must still make monthly payments on their first home's mortgage as well as monthly payments on the mortgage for the second home. This type of bridge loan is not for the faint of heart or financially strapped.

As with most speciality loans, the terms and conditions on bridge loans may vary greatly from lender to lender. Borrowers need to make sure that they fully understand the loans that they are considering. The best deals on bridge loans will typically come from a lender that is providing both the bridge loan and the mortgage loan for the second home.

Bridge Loan Interest Rates

Interest rates on bridges loans are higher than regular mortgage rates. Interest rates on bridge loans can run as much as 2 percentage points higher than conventional 30-year mortgage rates.

Bridge Loan Costs

Bridge loans can have substantial fees and closing costs associated with them making them an expensive proposition. Fees and closing costs will vary from lender to lender.

Bridge Loan Terms

The term on a bridge loan (the amount of time until it must be paid off) can vary widely from lender to lender. The typical term for a bridge loan is one year, but lenders offer bridge loans with terms up to 36 months.

Alternatives to a Bridge Loan

In addition to the alternatives already listed at the beginning of this article, there are other loan alternatives to a bridge loan. A home equity line of credit (HELOC) can be used in place of a bridge loan to provide the necessary down payment funds. A borrower can either:

  • Take out a HELOC on their existing home and use the money as the down payment on the new home. When the old home is sold the primary mortgage and the piggyback second HELOC are paid off.
  • Take out a HELOC on the new home in the amount necessary to cover the down payment. When the old home is sold the borrower should use the proceeds from the sale to pay off the HELOC on their new home.

Using a HELOC in place of a bridge loan has some advantages. Most lenders do not charge any closing costs for a borrower to obtain a HELOC. In addition, the HELOC's interest rate may be lower than available bridge loan interest rates.

When using the HELOC as a means of obtaining down payment funds, it is important for the borrower to understand that they will have three simultaneous home loans:

  1. The mortgage on the first home with its monthly principal and interest payment.
  2. The HELOC with an monthly interest-only payment.
  3. The mortgage on the second home with its monthly principal and interest payment.

As can be seen, many of the loan options available to a borrower to bridge them from an old unsold house to a new already purchased house will entail some level of financial hardship in the form of multiple simultaneous loan payments. The ideal situation is to have the old house on the market or sold prior to or while purchasing a new home to avoid a bridging option altogether. Barring this, a borrower will have to look at their own financial situation to see what will work best for them. The HELOC route will have the least costs associated with it but the borrower will be servicing multiple loans. The first bridge loan option mentioned above will have only one loan to service, but will entail higher costs.

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