How does a bridge loan work?

What is a bridge loan?

A bridge loan, or bridge mortgage, is a loan you can obtain based on funds that already belong to you but are not yet available to you. In most cases, this refers to the equity in your home. For example, a bridge loan allows you to bridge the gap between buying a new home and selling your old one. In this case, you borrow the equity from your old home to help finance your new home. When you eventually sell your old home, you can immediately use the equity to repay your bridge loan.

The difference between a bridge loan and a home loan is that a bridge loan is a short-term loan that must be repaid with funds you already have on hand. In addition, the interest rate on a bridge loan is generally slightly higher than that on a home loan.

Various applications

In addition to the period between buying and selling your home, a bridge loan can also serve other purposes. For example, you can apply for a bridge loan following the death of a family member. If you lack sufficient financial resources at that time, this allows you to avoid having to wait for the inheritance.

Pros and cons of a bridge loan

A bridge loan can therefore provide some much-needed breathing room—for example, when purchasing a new home. In addition, the interest on a bridge loan is tax-deductible, which helps offset the higher interest rate to some extent.

However, there are also risks associated with a bridge loan. The term of your bridge loan is between 1 and 6 months, or, in exceptional cases, 1 or 2 years. If you are unable to sell your old home within that time frame, you will need to find another way to repay the loan.

How does a bridge loan work in practice?

In most cases, you will take out a bridge loan from the bank where you also have your mortgage. At most banks, the maximum amount of a bridge loan is 90% of your home’s value. If your home has already been sold on paper, the bank may also lend you 100% of its value. In this case, the amount of your current mortgage debt is deducted. The loan therefore finances the equity in your home. The interest rate you pay on the bridge loan varies by bank. Generally, it will range between 2% and 4%. Please note that closing fees and notary fees may also apply.

You only pay interest on the portion of your bridge loan that you have drawn down. If you do not draw down any funds, there is no outstanding balance and therefore no interest is due. However, the bank may charge you a reservation fee, which is a type of penalty interest for not drawing down the funds made available to you.

Example of a bridge

Jan once bought his current home for €100,000.

He is going to sell his house for €200,000. However, it will be a few more months before the new owners can move in.

This results in a surplus, or profit, of €100,000.

Jan has found his dream home for €300,000 and earns enough each month to qualify for a €200,000 mortgage.

He takes out a bridge loan for the remaining €100,000 and can move right into his dream home.

Once he receives the proceeds from the sale of his previous home some time later, he will pay off the bridge loan.

Interest is typically paid monthly throughout the term of the loan. In some cases, the interest can be paid off along with the outstanding balance at the end of the term.