A bridge loan is a temporary loan to secure your existing home. It bridges the gap between the price of a new home and your mortgage (for a new home) in the event that the existing home isn’t sold before moving to your new home.

You typically get a bridge loan through a bank or a mortgage lender. Although it can be structured in different ways, it is generally used to pay off the existing home’s mortgage. Bridge loans typically last for a few months or as long as a year, and you either have the option of making monthly payments on the loan, or you can pay upfront.

An example to help you visualize how you can use a bridge loan
Consider that the current value of your existing home is $200,000. You still owe a mortgage worth $100,000 on it, and you buy a new home worth $300,000. In such a case, if you take a bridge loan of $130,000, you might use $100,000 from it to pay your current mortgage. The remaining $30,000 can be carried forward toward your new house’s down payment, closing costs, and fees. So, you close the deal on your old house, move into a new one, and pay for both the new home loan and bridge loan simultaneously. You also have the option of paying your bridge loan upfront if you manage to sell your previous house. In this scenario, if you sell your previous house for $200,000, you can pay off the bridge loan worth $30,000 and use the remaining amount to pay the current home loan. As you are only borrowing money for a short span of time, banks and mortgage lenders won’t make much money from the loan, because of which bridge loans attract high interest rates.

Benefits and drawbacks of taking a bridge loan
Discussed here are some benefits and drawbacks of taking a bridge loan:

Benefits

• Bridge loans allow buyers to immediately put their current home on sale and buy a new one.
• Since the down payment on a bridge loan takes a couple of months to initiate, you might get a few months to allocate for funds to pay for the same.
• They are short-term loans, which can make it easier for you to repay for them.

Drawbacks

• Even though they are short-term, they have higher interest rates when compared to conventional home loans.
• You need to have a strong credit history to apply for bridge loans.
• Not all banks offer bridge loans, so financing for the same can be difficult.
• Different bridge loans have different fees that depend on the lenders and on your location, and they have fluctuating interest rates. For instance, this loan might carry no payments for the first couple of months but will accumulate interest for those months. For example, a bridge loan of $10,000 will have an administration fee of approximately 8.5% and an appraisal fee of around 4.75%.

As a result, many financial experts recommend putting your old home on sale before buying a new one. This gives you a window for arranging finances for the new home loan and the bridge loan that you might use pay off the old mortgage.