Your clients have found the perfect home — but they haven’t sold their old one yet. Buying the new home would require them to come up with the down payment and get approved for the mortgage while at the same time covering the costs of their existing mortgage.

Since this is a significant financial burden, your clients might want to apply for a Bridge Loan. But bridge loans can be complex — and they aren’t without risk. Here are some frequently asked questions to help explain this financing option.

What Is a Bridge Loan?

According to Investopedia, a bridge loan is a short-term loan — generally for a term ranging from six months to a year — that home buyers can use to meet their financial obligations. Interest rates on a bridge loan fluctuate depending on the market, but they’re typically much higher than interest rates on a mortgage. Origination fees are also higher, but the approval time is much shorter.

To get approval for a bridge loan, your clients will need an excellent credit score, as well as a low debt-to-income ratio.

How Does a Bridge Loan Work?

As Realtor.com explains, a bridge loan typically finances as much as 80 percent of the combined values of your clients’ old and new homes. For example, if they’re selling a home for $300,000 and purchasing a new one for $400,000, their loan would be at most $560,000. To make the bridge loan a viable option, they need to have either substantial savings or significant equity in their old home.

There are various ways a bridge loan can be structured, according to Bankrate. Some loans add the new debt on top of the existing debt, while others pay off the old mortgage at the closing of the loan. Interest may be charged upfront, on a monthly basis or at the end of the loan term.

If all goes well and your clients sell their old home within the term of the loan, they can simply apply for a new mortgage for just the new property. In most cases, the lender of the bridge loan will specify that the new mortgage is also with their organization.

If the old property doesn’t sell within the term of the loan, your clients can apply for refinancing. However, if that doesn’t work out, the lender can foreclose on the old property to recover its funds.

When Is a Bridge Loan a Good Idea?

Experts agree that it’s always better for buyers to first sell their old property before purchasing a new one. That said, there can be instances in which this isn’t possible, for example if they need to relocate for a job.

It’s also important to note that a buyer’s market is never a good time for a bridge loan. In a seller’s market, on the other hand, where you clients are confident they’ll sell their home in a short period of time, the risk is somewhat lower.

Proceed with Caution

With higher interest rates and no guarantee that their home will fetch the desired asking price within an acceptable period of time, a bridge loan involves a considerable amount of risk. That’s why, even if your clients qualify for a bridge loan, they’re best advised to proceed with caution and only use one if they have no other option.

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