What Is Bridge Financing?
Updated
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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.
Bridge financing for homeowners helps smooth the transition from one home to another. A homebuyer can use bridge financing two different ways:
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 bridge loan has its share of benefits and drawbacks for potential homebuyers. The benefits include:
Meanwhile, some of the drawbacks are that:
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%:
| BRIDGE LOANS | BRIDGE LOAN CLOSING COSTS | BRIDGE LOAN RATES | TOTAL COSTS |
|---|---|---|---|
| $100,000 bridge loan (low assumptions of 1.5% total closing costs and the prime rate) | 1.5% of the total | 4.75% | $ 6,250.00 |
| $100,000 bridge loan (high assumptions of 3% closing costs and the prime rate plus 2%) | 3% of the total | 6.75% | $ 9,750.00 |
Many lenders will offer bridge loans to homebuyers, including banks, credit unions, online mortgage brokers, and hard money lenders. However, the best place to start is with a local bank or credit union. Check with your real estate agent, as they'll likely be able to recommend several local lenders who have experience with bridge loans. Homebuyers, on the other hand, should try to avoid online hard money lenders since they typically charge the highest fees, and not all are reputable.
Bridge financing is riskier for both the lender and borrower, which is why these loans typically have such high costs. The biggest risk is that the borrower's existing home doesn't sell as fast as expected. If that were to happen, not only would interest continue to accrue but the buyer also might need to get an extension, which could incur additional fees.
The borrower could endure additional financial stress, as they'd be carrying two mortgages plus potentially paying on the bridge loan. If that becomes too much to bear, and they can no longer make payments, lenders could foreclose on both properties. Given those risks, homebuyers should consider all their alternative options first.
Homebuyers have several options in addition to bridge financing to assist them with the purchase of a new home before listing their existing one. These include:
Given the costs and risks associated with bridge financing, homebuyers should carefully consider all alternatives, including whether it might make more sense to move into a temporary living situation.
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