What is a real estate bridge loan, and how do they work?

Question: “I’m selling my current home and buying another one. Is this the kind of situation where I can use a bridge loan to cover the down payment on the new place? What is a real estate bridge loan exactly, and how do they work? Are they still available in 2014 (post housing crisis)?”

Yes, yours is a situation where this type of loan could be helpful. And yes, they are still available in 2014.

But I can’t say whether or not it will work for you, without knowing more of the details. So let me just explain the basics of  (A) what a bridge loan is, (B) how they work, and (C) how you might use one when buying your second home. Let’s start with a basic definition.

Bridge Loan — A type of short-term financing where the funds are used to “bridge” some kind of financial gap. For people in your situation (residential real estate), this type of loan can help cover the cost of a down payment on the second home, by using the equity you have in your current home as collateral. You would then repay the bridge loan with the proceeds from the sale of your first home.

According to Robert de Heer, author of Realty Bluebook, “Bridge loans are a sensible means of financing as long as the homeowner is able to afford the loan payments, and as long as the new home isn’t used as collateral to acquire the loan.”

In most cases, lenders will only give you a certain percentage of the equity you have. Most (but not all) bridge loans are limited to 75% – 80% of the homeowner’s equity. Depending on how much equity you have, this could easily be enough to cover a down payment on a second home. Here’s a scenario to illustrate what I’m talking about.

How a Bridge Loan Works

Let’s say I currently have $50,000 worth of equity in my house (the difference between my mortgage balance and the current value of my home). I want to sell the house I’m living in now and buy a second one, but I don’t have enough money saved up for the down payment on the second place. So I apply for a residential real estate bridge loan to cover this expense.

The lender says they are willing to give me a loan for 75% of my current equity, which comes out to $37,500. I can now put that money toward the down payment on my next house. When my current home sells, I can use the proceeds from that sale to repay the bridge loan. (It is, after all, a form of short-term financing.)

Pros and Cons of Using One

As you might imagine, real estate bridge loans have certain pros and cons associated with them. We just talked about the primary “pro” above. They allow you to leverage your home equity to obtain short-term funding, which can then be used to cover some other expense (such as a down payment on a new house). So they serve as a form of transitional financing.

But there could be a downside to the loan as well. Here are some things to keep in mind:

  • The terms and structure of bridge loans can vary quite a bit. Some of them have regular payments that combine principal plus interest, while others have an interest-only structure with a large balloon payment at the end (though these are less common in 2014). You need to know how it will be structured before you move forward.
  • You might pay a higher interest rate on the bridge loan, than what you would pay on a regular mortgage. So be sure you understand the full cost including any fees.
  • In some cases, the closing costs that are applied to bridge loans can make them cost-prohibitive.
  • If your old home doesn’t sell within the expected time frame (a common scenario in the current economy), you could end up with two mortgage payments at the same time — on top of your bridge loan payments. This financing strategy is best suited for a strong market, where houses are selling fast.

This article answers the question: What is a real estate bridge loan, and how do they work? If you have additional mortgage-related questions, try using the search box at the top of this website. There’s a lot of information on the site, so there’s a good chance you’ll find what you need.