Bridge loans: how they work and how lenders count them

What is a bridge loan?

Fannie Mae’s definition is by purpose: when a borrower obtains a bridge (or swing) loan, the funds can be used to close on a new principal residence before the current residence is sold. Regulation Z uses the words “temporary or bridge loan” and gives the example of a loan to finance the purchase of a new dwelling where the consumer plans to sell a current dwelling within 12 months.

Neither source gives a standard interest rate, fee, loan amount or repayment schedule for bridge loans, so Payotte gives none. Those terms are set by each lender, and you should compare them in writing.

How does a lender count a bridge loan?

The lender looks at your monthly debts against your income. See debt-to-income ratio. On the Fannie Mae side, a bridge loan produces a contingent liability that must be considered part of your recurring monthly debt obligations and included in the ratio.

Fannie Mae waives that requirement if the lender documents both of these:

1. a fully executed sales contract for the current residence, and
2. confirmation that any financing contingencies have been cleared.

The same two items appear in the Selling Guide’s rule for a pending sale of your principal residence, discussed in selling and buying at the same time. Without them, both your current payment and the new payment (PITIA) are used when the old home will not close before the new loan.

What does federal law say about bridge loans?

Regulation Z’s ability-to-repay rules, in 12 CFR 1026.43(c) through (f), do not apply to a “temporary or bridge loan with a term of 12 months or less.” The regulation’s examples are a loan to buy a new home when you plan to sell a current one within 12 months, and a loan for initial construction of a dwelling. The CFPB’s official interpretation (comment 43(a)(3)-1) adds that for a renewable bridge loan, the term excludes any renewal period, if each renewal is for one year or less.

That exemption is about the ability-to-repay checks in paragraphs (c) through (f). It does not tell you the loan is a good idea. Read the Loan Estimate and the Closing Disclosure carefully (closing costs explained).

What other ways exist to bridge the gap?

• Savings or other funds you already have.
• A home equity loan or line of credit on your current home. See home equity loan vs HELOC. Ask the lender for the rules on a home that is about to be listed.
• A later possession date or a rent-back, negotiated in the sales contract.
• Waiting until the sale is under contract with financing contingencies cleared, which can remove the old payment from the lender’s count.

A simple illustration

This example is hypothetical and shows only how the debt rule works. Suppose your income is $10,000 a month, your current home payment is $2,000, and the new payment is $2,800. If you use a bridge loan and the lender does not have the sales contract and cleared contingencies, the lender counts the bridge loan as a contingent liability in your debts, in addition to the housing payment. If it has both documents, Fannie Mae will not require the bridge debt to be included in the ratio. Ask your lender to run both scenarios.

What should I ask a lender?

• What is the loan term, and is it 12 months or less?
• How is repayment due: at the sale of the old home, or on a date?
• What are all the fees, as shown on the Loan Estimate?
• Does it use the Fannie Mae rules above for my new mortgage?
• What happens if the old home sells later than planned?

Where states differ

The Fannie Mae and Regulation Z rules above apply across the country. States set the closing process, transfer taxes and disclosure rules for both homes. Use the closing costs calculator and transfer tax calculator for your state, and read the cost of selling a house to see what you may owe when the old home closes. The mortgage calculator can test your new payment.