What is a Bridge Loan? How Does it Work?

Like their name implies, bridge loans are meant to “bridge the gap” until a borrower can get more permanent financing, such as a mortgage or term loan. These loans are also called swing loans, interim financing and gap financing. They are usually short-term loans backed by collateral with high interest rates and fees.

Bridge Loan Definition

A bridge loan is intended to “bridge the gap” until you can secure more permanent long-term financing. Also known as swing loans or interim or gap financing, these loans are short-term loans with maturities generally up to one year and are usually secured by some sort of collateral. Most of the time, this collateral is the purchase or real estate being financed by the loan. These loans may be made by the same lender that will make the long-term financing. Many people are familiar with these loans when purchasing a new home when a previous home has yet to sell. Homebuyers may resort to using a bridge loan to snap up a property quickly before their old home sells.

How Does a Bridge Loan Work?

Bridge loans can work in a variety of ways, depending on what is being financed.

Residential Bridge Loans

Bridge loans may be used by individuals who are buying a new house before selling their old house. In some cases, the loan is used to pay off the mortgage on the old home and serve as a down payment for the new home. Other times, it is opened as a new lien and only used to pay for a down payment on the new home, adding additional debt on top of your two mortgage payments. Typically, the home being sold is used as collateral for the loan.

Let’s say you own a $200,000 home you want to sell, and you have $160,000 in equity on this home. This means that you have $40,000 left on your mortgage. If you take out a bridge loan for $70,000, $40,000 of this loan would be used to pay off the rest of your mortgage. The remaining $30,000 (less fees, such as origination or appraisal fees) can be used for down payment and closing costs on the home you’re buying. In this case, you’ll be responsible for making payments on your new mortgage. Most homebuyers use the proceeds from the sale of the old house to pay off the loan in full.

In another scenario, the bridge loan is only used as down payment for the new house. You would still be paying the $40,000 remaining on your mortgage on your old home until it sells. Since you used the $70,000 bridge loan as down payment for your new house, you would also be paying the mortgage on your new home. This means you would be responsible for paying two mortgages until your old home sells. Once your old home sells, you can use the proceeds to pay off the loan.

Commercial Bridge Loans

Commercial bridge loans used to purchase real estate work similarly to residential ones. In the same way that a homebuyer uses one of these loans, a business owner could use a loan when moving from an old office to a new office. Or, a company may use the loan to quickly snap up property that it would lose otherwise while waiting for long-term financing. Finally, a company may also use this type of loan to get a purchased property up to standards for a traditional commercial mortgage. This includes properties that may need significant renovation or that have low occupancy rates. Borrowers may also opt for a bridge loan if their credit score needs improvement.

Businesses may also use bridge loans for cash flow issues ahead of receiving long-term financing. For example, a startup may expect to close a new round of equity financing within the next six months, but still needs cash for working capital, payroll, operations, inventory, supplies and other expenses. In this case, the startup might apply for and use the gap loan until the equity financing comes through.

Average Bridge Loan Rates, Terms and Fees

Rates, terms and fees on bridge loans vary widely. These loans may be structured differently depending on what is being financed, who the borrower is and who the lender is.

Interest RatesUp to market rate + 2% or more
Loan TermsTypically 6- or 12-months
Loan-to-Value RatioUp to 80%
Fees
  • Origination fee
  • Appraisal fee
  • Escrow fee
  • Title fee
  • May have a prepayment penalty

Repayment

  • Unamortized:
    • One-time repayment at the end of the term or when your old home sells (if earlier than the term), with interest accruing during this time
    • Interest-only payments each month with a balloon payment at the end of the term or when your old home sells (if earlier than the term)
  • Amortized: Fixed monthly payments

How you repay a bridge loan will depend on the loan itself. These loans can have very different terms and repayment structures. On residential bridge loans, you may not be required to make the remaining payments if your home is sold before the term of the loan is up. For example, let’s say you have a six-month loan that requires $1,000 interest-only payments each month and a balloon payment in the last month. If you sell your home two months before your loan term is up, you won’t have to pay the $1,000 interest-only payment for the last two months of the loan terms. Instead, you’ll pay the balloon payment and close out the loan.

How to Get a Bridge Loan

Homebuyers and businesses can get a bridge loan from a bank, credit union, private lender or alternative lender. In general, we recommend getting the loan from the same bank or lender that will make the long-term financing or mortgage. This can help you get better rates and terms on the loan. Unlike traditional loans, many lenders do not have strict underwriting guidelines for these types of loans. This means that there may be no hard credit score, debt-to-income ratio (or debt service coverage ratio for businesses) or other requirements. Instead, lenders may use a “common sense” approach and look at the situation at hand. A lender will likely approve a loan application if the loan makes sense and the borrower is likely to repay. If you are considering one of these loans, it’s best to discuss options available to you with your lender.

Pros and Cons of Bridge Loans

For homebuyers, bridge loans can be a risky proposition. Not only are you adding to your existing mortgage debt burden, but there is no guarantee your old home will sell before the term of the loan is up. This could leave you in a sticky financial situation as you would have to pay off the loan without having the proceeds from the sale of your house. For business owners or investors, bridge loans can oftentimes make sense when purchasing commercial real estate or getting cash-flow help while waiting for long-term financing.

Pros:

  • Quickly purchase a property that you would lose if you waited for traditional financing
  • Ability to purchase a “move-up” home or property
  • No payment may be required on the loan until term is up
  • Get time to prepare a commercial property for a traditional commercial mortgage
  • Cash-flow infusion for businesses and startups until they can close long-term financing

Cons:

  • High interest rates and fees
  • Increased debt burden could lead to undue financial stress or default
  • Can be difficult to qualify for these loans (you may have to be qualified to have two mortgages)
  • No guarantee old house or property will sell before term of the loan is up
  • Some loans may have prepayment penalties

We recommend homebuyers try to sell their old home before purchasing a new home to avoid taking out a bridge loan. However, if this is not possible, we suggest borrowers consider other options. You should see whether you can qualify for a home buyer’s assistance or down payment program. If that’s not an option, home equity loans and lines of credit can be used in the same way as a bridge loan and will likely have lower interest rates.

Comments and Questions