Bridge Loans: How They Work and When to Use Them

Timing plays a crucial role in real estate transactions. If you are looking to buy a new home before selling your current one, you may need short-term financing. 

This is where a bridge loan becomes useful, providing temporary financial support until you secure long-term financing or complete the sale of your existing property. 

But how exactly does a bridge loan work? Is it the right solution for your situation? And what are the risks and potential alternatives? This content will help you navigate these questions and make an informed decision.

What is a bridge loan? 

A bridge loan is a short-term financing option designed to provide immediate liquidity to homeowners or businesses as they transition between properties or financial obligations. 

In the real estate market, it allows owners to purchase a new home before selling their current one, leveraging their existing home as collateral. 

Thus, bridge loans generally have higher interest rates than traditional mortgages due to their short-term nature and greater risk to lenders. 

They typically last from 6 to 12 months, requiring borrowers to have a clear repayment strategy, whether through the sale of their home or by securing long-term financing.

How does a bridge loan work? 

A bridge loan provides quick access to funds using the borrower’s existing property as collateral. 

The loan amount is based on the equity available in the current home, and once the home is sold, the proceeds are used to repay the bridge loan. 

Repayment structures vary by lender, but the two most common types are: 

• Interest-only payments – The borrower makes monthly payments covering only the interest, with the total loan balance due upon the sale of the home. 
• Deferred payments – No monthly payments are required; instead, the total loan amount (including interest) is paid all at once at the end of the term. 

Since these loans are short-term, borrowers must have a strong exit strategy to avoid financial difficulties.

Bridge Loans vs. Traditional Loans 

While both bridge loans and traditional mortgages provide financing, they differ significantly in their purpose, terms, and approval process. 

A bridge loan is intended for short-term financing, typically lasting less than a year, while a traditional mortgage is designed for long-term repayment, from 15 to 30 years. 

Additionally, bridge loans have higher interest rates and require quicker repayment, whereas traditional mortgages offer lower rates with predictable monthly payments. One of the major advantages of a bridge loan is its fast approval process. 

Unlike traditional mortgages, which require extensive credit checks and documentation, bridge loans primarily focus on the value of the collateral. 

This makes them ideal for real estate owners in competitive real estate markets who need to act fast. 

However, the speed and flexibility of a bridge loan come at a cost: higher interest rates and a shorter repayment period mean that borrowers must be confident in their ability to sell their home quickly or secure long-term financing.

Requirements for a Bridge Loan 

Qualifying for a bridge loan involves meeting specific lender requirements, including: 

• Sufficient Home Equity – Most lenders require at least 20% equity in the current home, as it serves as collateral.
• Good Credit Score – While bridge loans may have more lenient requirements than traditional mortgages, a credit score of 680 or higher is typically preferred. 
• Stable Income – Lenders assess income stability to ensure that borrowers can manage the financial obligations of the loan. 
• Low Debt-to-Income Ratio – A lower DTI ratio improves eligibility and increases the likelihood of securing favorable loan terms. 

As bridge loans present greater risks for both lenders and borrowers, these requirements help ensure that applicants have the financial stability to manage the repayment within the short-term loan period.

Is a Bridge Loan a Good Idea? 

Deciding whether a bridge loan is right for you depends on your financial situation and real estate goals. Consider the following advantages and disadvantages before making a decision: 

Pros

• Quick access to cash – Offers rapid liquidity, allowing buyers to purchase a new home without waiting for their current home to be sold.
• No property sale contingency – Strengthens purchase offers by eliminating the need for contingencies based on the sale of an existing property.
• Flexible payment options – Some lenders offer interest-only payments, reducing short-term financial burden. 

Cons

• Higher interest rates – Generally 2-3% higher than rates for traditional mortgages, increasing overall borrowing costs.
• Short repayment period – Must be repaid within 6 to 12 months, requiring a solid exit strategy.
• Possibility of double mortgage payments – If the current home does not sell as expected, borrowers may end up making two mortgage payments in addition to the interest on the bridge loan. 

If you are confident that your home will sell quickly and have a well-defined repayment plan, a bridge loan can be an effective solution. 

However, if the timeline for selling your home is uncertain, the financial risks may outweigh the benefits.

What to Consider Before Taking a Bridge Loan 

Before applying for a bridge loan, carefully review your financial situation and ask yourself:

• Can I comfortably afford the higher interest rates?
• Do I have a Plan B if my home takes longer than expected to sell?
• Will the value of my new home increase, making this risk worthwhile?
• Am I prepared for additional fees, such as closing costs and loan fees? 

If unsure, consulting a financial advisor or mortgage specialist can help determine if a bridge loan is the right choice for you.

Alternatives to Bridge Loans 

If a bridge loan does not seem like the best option, there are alternative financing solutions that might better meet your needs:

Home Equity Loan 

A home equity loan allows homeowners to borrow a fixed amount based on the property’s value. 

This type of loan generally comes with lower interest rates than a bridge loan and fixed monthly payments, making it a more predictable option. 

However, home equity loans require strong credit and stable income and can take longer to process than a bridge loan.

Home Equity Line of Credit (HELOC) 

A HELOC operates like a revolving credit line that homeowners can borrow from as needed. 

It typically has lower interest rates than bridge loans and offers flexibility in how funds are used. 

On the downside, HELOCs have variable interest rates, meaning payments can fluctuate over time. Additionally, borrowers must have a solid credit profile to qualify.

80-10-10 Loan 

An 80-10-10 loan (also known as a piggyback mortgage) involves taking out two loans:

• 80% of the home’s price is financed with a traditional mortgage. 
• 10% is covered by a second loan. 
• 10% is the borrower’s down payment. 

This option helps borrowers avoid private mortgage insurance (PMI) and reduce upfront costs.

However, it requires a higher credit score and approval for two separate loans, making the process more complex.

A bridge loan can be a valuable tool for real estate buyers who need short-term financing, but it comes with risks. 

The high interest rates, short repayment period, and potential for carrying two mortgages make it essential to carefully evaluate your financial situation before proceeding. 

Before committing, explore alternative financing options and consult a mortgage expert to determine the best course of action. 

If used wisely, a bridge loan can provide the flexibility needed to secure your dream home without missing opportunities. 

For more insights on real estate financing and strategies, explore our blog! Want a suggestion? Also read our content explaining how tiny home financing work!