Why Bridge Loans are Risky

Bridge loans help homeowners bridge the gap between selling a home and buying a new home. Bridge loans are known as "gap" loans or "swing" loans. While bridge loans can help a transaction close, there are risks involved.

Different Types of Bridge Loans:

Mortgage Payoff Bridge Loans

A mortgage payoff bridge loan allows you to borrow a loan that includes both a new down payment and an amount equal to the your existing mortgagee.  The down payment is used for the new home purchase.  With this loan type, you pay one mortgage only. The old mortgage is paid off with the new bridge loan.  The loan is due once you sell your home.  

The risk involved with mortgage payoff loans involves the value of your home.  The home may sell for an amount that may less than the amount owed on the bridge loan, or may not sell at all.  Market conditions are unpredictable and can be forced to find additional financing with higher costs and fees.  

Equity Loan Bridge

An Equity Bridge loan requires collateral in your home and borrows against the equity, as the name suggests. Your new loan amount is based on the equity of your home.  The proceeds of the loan are used as a down payment.

This type of financing involves even more risk. That is, you have three loan payments: your original mortgage, your bridge loan and your new home mortgage.  Additionally, the risk of value remains in the property as well.  If your home doesn't sell, you can face foreclosure and will still have to pay off all loans against the property.

Compounding the Risks

In a strong housing market, bridge loans typically are not necessary. Homes sell quickly and values increase, allowing you to cash out and have a down payment to buy a new home. But when the housing market slows, homes are harder to sell, and see their value decrease significantly.  Therefore, the slowing market that made it necessary to get a bridge loan, makes it just as difficult to sell the home at a value high enough to pay off the mortgage and the bridge loan.  The risks are compounded because the borrower becomes highly leveraged, owing more than they can pay off in a sale.

Time and Cost Risks

A typical bridge loan is for six months. If you are unable to sell within established time frames, you will be forced to refinance the bridge loan, which can be more expensive. Bridge loan interest rates run about 2 percent higher than 30-year, fixed-rate mortgages. If your house doesn't sell, the lender will carefully review financial. The review may result in increased rates and extending the term of the mortgage.