What is a bridge loan?

In a perfect world, your current house would be under contract to sell before you made an offer on a new one. Proceeds from the sale provide a down payment for the next house and voilà! You’d move seamlessly from one house — and mortgage — to the next.

But we don’t live in a perfect world.

Bridge loans give you the option to take more time between transactions by letting you access your home equity before you sell, says Jerrold Anderson, vice president of residential lending at Alliant Credit Union.

And in doing so, bridge loans help you avoid making a contingent offer on the home you want to buy. Sale-contingent offers let you back out of the contract if your current home doesn’t sell, and they make sellers nervous.

In markets where sellers often get multiple offers, those that come with conditions may not be able to compete against offers from buyers who already have the funds.

» MORE: How to buy and sell a house at the same time

How bridge loans work

When applying for a bridge loan, expect the same credit and debt-to-income requirements as a mortgage.

Most bridge loan lenders won't go above an 80% loan-to-value ratio, or LTV, says David Alden, president and COO of First Savings Mortgage in McLean, Virginia. So you’ll need to have at least 20% equity in your current home for a bridge loan to be an option.

Bridge loans are generally used in one of two ways:

1. As a way to pay off your current mortgage, putting any excess toward your new down payment.

2. As a second mortgage that becomes your down payment for the new house.

Example 1: Mortgage payoff and down payment

Let’s say your current home value is $300,000 and you owe $200,000 on the mortgage. A bridge loan for 80% of the home’s value, or $240,000, pays off your current loan with $40,000 to spare. If the bridge loan closing costs and fees are $5,000, you’re left with $35,000 to put down on your new house.

Example 2: Second mortgage

Let’s again say your current home value is $300,000. With $200,000 on the mortgage, you have $100,000 in equity. A bridge loan for 80% of your equity would provide $80,000 for you to apply toward the purchase of your next home.

Both scenarios assume your old house sells, allowing you to pay off the bridge loan, plus interest, fairly quickly. If it doesn’t sell in time, you may owe the full amount of the bridge loan on top of your new mortgage payment. This could lead to significant financial stress or even default.

Bridge loan pros and cons

Pros

• You can make an offer on the house you want without a sale contingency.

• Payments may be interest-only or deferred until you sell.

Cons

• You'll pay high interest rates and APR. Your lender may even use a variable prime rate that increases over time.

• You may have to pay for an appraisal along with closing costs and fees.

• You may own two houses — with two mortgage payments — for a bit.

• You're limited to 80% LTV, which requires more than 20% equity to yield enough money for the house you want.

When to use a bridge loan

If you find yourself in one of these sticky situations, a bridge loan might keep things on track.

• Sellers in your area won’t accept contingent offers.

• You can’t afford a down payment without the proceeds from your current house.

• You’re confident your house will sell but prefer to secure a new home before listing it.

• Closing on your current house is scheduled after the closing date for your new house.

Alden says First Savings Mortgage has already made more bridge loans in 2018 than at any time since the financial crisis a decade ago. Their renewed popularity shows how useful they can be for people who want to win contracts in competitive markets.

How to find a bridge loan lender

“Start local,” Anderson says. Rather than searching “bridge loan lenders” on the internet, he recommends contacting a trustworthy bank or credit union in your market.

Stay away from collateral-based "hard money" lenders who advertise “fast cash” online. They may offer bridge loans, but they’ll charge even higher interest rates for them than traditional lenders and may not be reputable.