Bridge financing is an interim funding solution used by homeowners as a bridge until they close the sale of their existing home. Bridge loans, also known as swing loans, allow a homebuyer to put an offer on a new home without first selling their existing one. This financing solution, however, has high costs, requires a borrower to have 20% equity in their old house, and is best suited for rapidly moving real estate markets.
What is bridge financing?
Bridge financing for homeowners helps smooth the transition from one home to another. A homebuyer can use bridge financing two different ways:
- A short-term loan for the full value of the existing house. The buyer will receive a bridge loan to pay off the existing mortgage, with the excess going toward the down payment on the new home. Once the sale of the current house closes, the homeowner pays off the entire bridge loan.
- A second mortgage on the existing home secured by the equity in the property. A homeowner can use those proceeds as a down payment on a new home. They then pay off both the existing mortgage and the bridge loan with the proceeds from selling their home.
By using the equity in their existing house, a homebuyer can finance the down payment on a new home without having to close the sale of the existing property. That way, a homeowner won't have to move into a temporary housing situation if their home sells faster than they expected. It can also give a homebuyer an edge over other buyers in a fast-moving market since they won't have to make a contingent offer.
However, homeowners who are interested in bridge loans need to be aware of four major features of this financing:
- A borrower needs to have at least 20% equity in their existing home.
- They must qualify to hold both mortgages.
- Bridge loans are short-term financing and usually have terms of six to 12 months.
- Bridge loans have higher interest rates and fees compared to a home equity loan.
What are the pros and cons of a bridge loan for homebuyers?
A bridge loan has its share of benefits and drawbacks for potential homebuyers. The benefits include:
- They enable a home buyer to shop confidently for a new house before listing their old home.
- They give a buyer the ability to make an offer on a home whose seller won't accept contingent offers.
- A homebuyer can close the sale of their new home before their existing one, providing for a smoother transition.
Meanwhile, some of the drawbacks are that:
- They require a fast-moving real estate market to be a practical option.
- They tend to be more expensive, both in interest rate and closing costs, compared to a home equity loan.
- A homeowner needs at least 20% equity in their existing home.
- The homebuyer must be able to qualify to own both homes in case the existing one takes longer to sell than expected.
- A bridge loan can cause financial stress from potentially having to carry two mortgages as well as the mounting interest from the bridge loan.
How much are bridge loan rates?
Bridge loan rates vary depending on the location, lender, and credit quality of the borrower. They'll typically have both closing costs and interest expenses. Borrowers usually use the proceeds of the loan to pay the closing costs, which often include:
Total closing costs can range between 1.5% and 3% of the loan's value.
In addition to that, the loan will accrue interest each month, with lenders typically charging between prime and prime plus 2%. Because the prime rate fluctuates with the interest rate set by the Federal Reserve, a bridge loan's interest rate can vary each month.
Here's an example of the range of costs for a $100,000 bridge loan with a 12-month term using the current prime rate of 4.75%: