Definition
A bridge loan is a short-term loan that helps a borrower “bridge the gap” between buying a new home and selling their current one. It provides temporary financing to cover the down payment or purchase price of a new property until the borrower’s existing home is sold or long-term financing is secured.
Explanation
Bridge loans are often used by homebuyers and real estate investors who need quick access to funds but have their money tied up in an unsold property. These loans typically have high interest rates and short repayment periods (6 months to 3 years) because they are designed to be repaid quickly once the borrower’s existing home sells or they secure permanent financing.
Most bridge loans fall into two categories:
- Closed Bridge Loan: The borrower has a clear plan to repay the loan, such as a pending sale on their current home. These loans often come with set repayment terms.
- Open Bridge Loan: The borrower does not yet have a buyer for their current home but needs immediate funds. These loans are riskier and may have higher interest rates.
While bridge loans can provide convenience and flexibility, they come with risks, such as carrying two mortgages at once if the original home does not sell as quickly as expected.
Example
A homeowner is in the process of selling their current house for $500,000 but finds their dream home for $600,000 before their home sells. Instead of waiting and risking losing the new property, they take out a bridge loan for $100,000 to cover the down payment on the new house. Once their current home sells, they use the proceeds to pay off the bridge loan.