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Bridge loans: Understanding how they work

You’ve found a great new home to buy, but your current home hasn’t sold. That’s the financial dilemma some homeowners find themselves stuck in.

Without the funds available to purchase a new home immediately, you may lose out. A bridge loan can help “bridge the difference” when you want to buy, but you still have to sell.

It can be particularly helpful in a hot real estate market when you need to act fast.

How do bridge loans work?

There are two different ways to use a bridge loan. In the first situation you use the bridge loan to

  • Pay off your existing mortgage
  • Free up cash for a new down payment

When your existing home sells, you use the proceeds to pay off the bridge loan.

It buys you a little time because with a bridge loan you’re not tied to a monthly payment. Instead, the interest is tacked on to your loan balance.

You’re now free from paying two mortgages at once, but usually you have to repay the loan with interest. That’s typically within six to 12 months.

There’s another drawback. Bridge loans do come with a higher interest rate.

In the next situation you use the bridge loan like a home equity loan. You don’t replace your existing mortgage. Instead you

  • Take a smaller bridge loan to cover the new down payment.

Again, once you’re able to sell your current home, you pay off the bridge loan and your remaining mortgage with the proceeds.

In this situation you still have to keep up with your old mortgage payment, while at the same time also paying on a new property. On a positive note, it does give you the cash you need fast.

Young family on tight rope

Ways to use a bridge loan

  • To buy a new home when you’re waiting to sell your current home
  • To avoid the risks of a “contingent” offer
  • To provide some cash flow
  • To keep a deal from falling through due to insufficient financing

When is a bridge loan risky?

Essentially, you do end up owning two homes. The hope, of course, is that’s it’s just for a short time period.

Normally, people pay off a bridge loan when they sell their current home. Sometimes, though, it’s a gamble.

While some programs allow for an extension, it can be risky in certain housing markets if your home doesn’t sell within a reasonable amount of time.

There are also some fees attached to taking out a bridge loan, so it’s best to understand exactly how much money you’ll end up owing.

You’ll then want to compare that amount to the immediate financial boost and other benefits you could get from taking out such a loan.

About the author

I am from Chicago, IL and I have been lending in this area for 20+ years. My team and I strive to give you an enjoyable mortgage experience while providing you the best programs and rates! I am also offering a FREE mortgage analysis to determine if refinancing is right for you.

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