What Is a Bridge Loan and How Does It Work?

A bridge loan is designed to provide short-term funding until a borrower secures permanent financing or pays off an existing obligation such as a mortgage loan. Other terms used for bridge loans are interim financing, gap financing, or swing loans. All suggest the short-term nature of the financing. 

This type of loan is often used toward the purchase of a new house, especially in cases where the buyer remains employed during the transition. Bridge loans use the buyer’s current home as collateral, just as home equity loans and home equity lines of credit (HELOCs) do. The borrower can put part of the proceeds from a bridge loan toward a down payment on a new home, but the bridge loan does not take the place of a mortgage loan. That’s because bridge loans usually must be repaid within three years.

Structure

The costs, conditions, and other terms of a bridge loan can vary greatly, depending on their specific purpose. For example, some bridge loans pay off the mortgage on a homeowner’s current home as soon as the loan closes, while others simply add to the existing mortgage principal. The handling of interest may also vary, with some bridge loans requiring monthly payments and others requiring interest payments in a lump sum up front or at the end of the loan’s term.

Bridge loans usually have a term of about six months, although they can be as long as three years. Lenders rarely extend the term unless borrowers agree to finance their new mortgage with them. The interest rate on a bridge loan typically falls in a range between the prime rate and 2 percentage points over the prime rate.

Costs

The closing costs on a bridge loan can run into the thousands, including up to 2 percent of the loan and origination fees. 

How It Works

For this example, assume that the mortgage on your current home has a balance of $50,000, and you obtain a bridge loan for $70,000. You would pay off the mortgage with $50,000 and pay another $2,000 in closing costs, leaving you with $18,000 to put down on your new house.

Key Takeaways

If you’re debating whether or not to use a bridge loan, it’s important to fully understand how it works and what other options are available to you. Talk to a financial advisor to make sure you’re making the best choice for your situation.