How Does a Bridge Loan Work?

Andrew Weber is a senior director of Planning Philosophy, Research and Guidance at Northwestern Mutual.

Buying a home when you already own one can be a challenge.

On the one hand, you’ve got the stresses of buying a house—determining your budget, finding a mortgage lender, attending open houses, scheduling inspections, making offers and closing. On the other, you’ve got the stresses of selling your house. And you might worry about affording your new home before finding a buyer for your current property.

While you could wait until you sell your home before making an offer on a new one, that’s not the only option. A bridge loan could help you temporarily close this funding gap until you sell your current place.

Below, you’ll learn what bridge loans are and how they work. And we’ll walk through the steps involved in applying for one and take a closer look at the pros and cons.

What are bridge loans in real estate?

A bridge loan is a type of short-term loan designed to provide cash until more permanent financing can be secured. They are commonly used in real estate purchases. Bridge loans are also known as swing loans, gap loans and interim financing.

How do bridge loans work?

By applying for a bridge loan, you gain access to the funds you need to buy your new house even before your current home is sold. Usually, you would use these funds to pay off your first mortgage. Or you might treat the bridge loan as a second mortgage. In this case, you’d use the proceeds of the loan to make a down payment on your new home until you are able to sell your existing home. In both scenarios, when your first home sells, you would use the proceeds of that sale to pay back the bridge loan.

But if you don’t have a bridge loan, you’d probably need to make a contingent offer on a new house. With a home sale contingency, you express your desire to buy a home—but only once your current home sells. Some sellers may not accept contingent offers, especially in a market that favors sellers.

How long do bridge loans last?

When bridge loans are being used to finance a real estate purchase, they will typically have a term of either six months or one year. (Some lenders may offer longer terms.) Usually, the terms of a bridge loan will not be extendable, so you have to pay it off on the original schedule.

Because bridge loans have such short terms, they will often carry higher interest rates than traditional 30-year mortgages. Your first home will act as collateral for the duration of the loan, so it’s important to be confident that you can pay back your bridge loan. It’s a good time to talk with your Northwestern Mutual financial advisor to see how the loan might fit with your overall finances. Your financial advisor may even be able to point out an opportunity for a different source of short-term money.

How to get a bridge loan

Applying for a bridge loan is similar to applying for your first mortgage. First, you’ll need to shop around and find a lender that offers bridge loans. Then, you’ll need to make sure you meet their requirements for lending. While these vary from lender to lender, some factors include the following:

Home listed for sale

Because most homeowners can repay their bridge loans only when their current home sells, many lenders will require that your current home is listed for sale before they will lend you a bridge loan.

Equity in your current home

Bridge loans are rarely large enough to cover the full value of your current home. They’re typically capped at 80 percent of your loan-to-value (LTV) ratio, so you’ll usually need to have at least 20 percent ownership or “equity” in your current home.

Credit score

Lenders of bridge loans often prefer borrowers with a very good or excellent credit score—somewhere in the 740 to 850 range. But you won’t necessarily be turned away if you fall below this range. You may qualify for a smaller loan, which would require you to have more equity in your current home.

Debt-to-income ratio

Bridge loan lenders also prefer borrowers with a relatively low debt-to-income (DTI) ratio. This financial metric quickly shows how much borrowing you’ve done compared to the money you’ve got coming in. Keeping your DTI under 50 percent can make approval easier, and the lower your ratio the more attractive you’ll typically be.

Pros and cons of using a bridge loan

Before applying for a bridge loan, it’s important to consider the potential benefits and drawbacks:

Bridge loan benefits

The primary benefit offered by bridge loans is the possibility of purchasing a new house before your current home sells. Other benefits include:

• Speed of financing: Many bridge loan lenders will provide the money in as little as two weeks.
• Flexibility of payments: Depending on your lender, you may be able to make interest-only payments or defer payments while you wait for your current home to sell.
• Attractiveness as a buyer: Without a bridge loan, you may be able to make an offer on a home only with the contingency that your current home sells, which may turn off some sellers.

Bridge loan cons

The largest drawback of taking out a bridge loan is the fact that, like any other loan, it must be paid back with interest—and rates are typically higher than traditional mortgages. Other potential cons to consider include:

• Origination fees: Just like with mortgages, lenders of bridge loans will often charge origination and closing fees, which ultimately increase the cost of purchasing your new home.
• Equity requirements: In most cases, you’ll need at least 20 percent equity in your current home to qualify.
• Difficulty extending: If your current home takes longer to sell than you expect, your bridge loan lender may offer an extension only if you agree to finance your new home with them.
• Risk of foreclosure: When you borrow a bridge loan, you use your current home as collateral. If your loan comes due before your current home sells, the lender may decide to foreclose on it.

Alternatives to bridge loans for home buying

While some homeowners find bridge loans to be a helpful tool, you may have other ways to finance your new home, including these:

Home equity loans and HELOCs

A home equity loan is a lump-sum loan (or second mortgage) that allows you to borrow against the equity you’ve built in your home. A home equity line of credit (HELOC) is similar, but it works more like a credit card than a traditional loan. In both cases, you’re able to access your home equity—often at cheaper rates and with lower fees than a bridge loan—to purchase your new home while you wait for your current home to sell.

Note that you typically cannot take out a HELOC on a home that is listed for sale, so pursuing this option would require some forethought. Additionally, some HELOCs carry an early repayment penalty, so it’s important to know your terms before borrowing.

Loans against life insurance

If you own a permanent life insurance policy that has accrued significant cash value, you may be able to borrow against that cash value to cover your down payment. Then when your home sells, you would pay back the life insurance loan. (But if you were to pass away before paying back the loan, it would reduce the death benefit that is ultimately paid to your beneficiaries.)

Personal loans

With a personal loan, your current home isn’t acting as collateral. While that often translates into higher interest rates compared to a bridge loan, home equity loan or HELOC, it also comes with more flexible repayment terms—giving you more time to repay it if your home takes longer to sell.

Piggyback loans

With a piggyback loan, also called an 80-10-10 loan, you may be able to purchase your new home even with a smaller down payment while avoiding private mortgage insurance (PMI). Under this framework, you would put 10 percent down on your new home. Then you would borrow one mortgage at 80 percent of the home’s purchase price and a second smaller mortgage to cover the other 10 percent. When your current home sells, you would use the proceeds of that sale to pay off the smaller mortgage.

401(k) loans

Finally, you may consider a 401(k) loan to borrow against your retirement savings. This would involve taking money out of your 401(k) to purchase your new home and then paying yourself back—with interest—over time. Ideally, you would be able to pay the loan back quickly upon your current home’s sale. Because the 401(k) money is intended for retirement, using it toward a home should be considered carefully.

Is a bridge loan right for you?

While everyone’s financial situation is unique, some common scenarios where you may consider using a bridge loan to finance the purchase of a new home include these:

• You can’t make a down payment on a new home before your current home sells.
• You don’t want to sell your current home before you have your new home lined up.
• You’re looking to buy in a market where sellers are unlikely to accept a contingent offer.
• The purchase of your new house is scheduled to take place before the closing date of your current house sale.
• You need to move urgently—for example, moving across the country to start a new job—and cannot wait until your current home sells.

Still not sure if a bridge loan is the right move for your financial situation and goals? Consider working with your Northwestern Mutual financial advisor. They can walk you through your options—including a bridge loan and all of your alternatives—and help you choose the best method.

Your Northwestern Mutual advisor can also take a look at your whole financial picture, including how you’re protecting and growing your money. Together you might find opportunities and blind spots that would otherwise be overlooked.

Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP^®, CERTIFIED FINANCIAL PLANNER^®, and CFP^® (with plaque design) in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.