What is a Bridge Loan and How Does it Work?

While securing the sale of one home before transitioning to your next is the ideal order of business, sometimes timing just doesn’t allow for it. So, what do you do if you must put a down payment on your new dream home before you’re able to sell your old one? A bridge loan might be the answer.

What is a Bridge Loan?

Bridge loans are a short-term loan meant to ‘bridge’ the gap in financing for those looking to move to a new home while waiting for their existing home to sell. Sometimes referred to as ‘gap financing’ or a ‘swing loan’, this type of loan allows homeowners to borrow against their current property to put a down payment on a new (typically a larger) home.

How Does it Work?

Bridge loans combine the mortgages of two homes together – freeing up funds to put toward your new home. Lenders typically require an excellent credit score and a low debt-to-income ratio from the borrower. In most cases, they will offer a maximum of 80% of the value of the two properties combined, so having a healthy amount of home equity in your current home is helpful.

A bridge loan can also be structured one of two ways. The first allows you to pay off any existing liens on your current property and direct the remainder toward the down payment on your new home. The second option allows you to use the bridge loan like a second mortgage; in this instance you would put the entirety toward the new home’s down payment. It’s important to remember that in either case, this is a short-term loan and is generally good for six months to a year.

Is it Right For Me?

Bridge loans have benefits and drawbacks; here are a few things to consider when trying to determine if this is right financial step for you:

If you are pressed for time in terms of coming up with a down payment for your new home, this is a great option
You can put your home on the market immediately, or wait until closer to your new-home possession date
Borrowers typically don’t have to pay interest on the remaining loan if their home sells before the term is over
You may not be required to start repaying the loan for a few months
You are taking on a new, short-term loan while still determining when your current house will sell so consider your comfort level when speaking with your mortgage broker or bank
Bridge loans cost more than home equity loans (HELOCS) and generally carry interest rates above the average fixed rate
Depending on the terms of the loan, you may be faced with prepayment penalties if you pay it off too early (so ask your bank upfront)
Your loan amount will reflect how much equity you currently have in your existing home

How Much Are Fees?

The short-term nature of these loans means they usually come with a higher interest rate – generally Prime + 2 or 3%. The lender may also charge an administration fee which typically falls anywhere between $200 and $500.

As with any home loan option, before deciding if a bridge loan is right for you, be sure to talk to your mortgage broker. While this type of loan is offered by most major banks, your broker will be able to advise you if it is, in fact, ideal for you and which lenders you should talk to.