What is a Bridge Loan?


A bridge loan can help when buying a house before yours sells

A bridge loan may come in handy when attempting to buy a home, especially in a hot market. Why?

If you're pressured to make an unconditional offer on your dream home because of competing buyers, or because an uncooperative seller refuses to accept your offer because it's conditional on the sale of your current home, it's possible, or even probable, that you may have to close on your purchase before your old home has sold and/or closed. Or when you sell the old homestead, the closing date of the sale, for whatever reason, doesn't match the agreed closing date of your purchase.

Suddenly, you realize that you'll not have the equity in your old home when you need it to close on your purchase. If the buyer of your home cannot or will not agree to your needed date, and the seller of your new home can't or won't budge either, where will you find the money to fulfill your purchase contract?

A bridge loan can provide the solution

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A bridge financing loan is a short-term financing tool that helps buyers to "bridge" the gap between old and new mortgages by allowing them to tap the equity in their current home for the needed down payment, while essentially owning two properties concurrently as they wait for the sale and/or closing of their existing home.

To be able to close on the agreed completion date contained in the Agreement of Purchase and Sale (APS) on their new home, a buyer is essentially borrowing the entire purchase price of their new property using the equity in their existing property, in addition to the unconditional APS for their present home, as security for the lender.

To calculate the amount of such a loan, take the purchase price of the new house, then subtract the value of the mortgage you'll need on the new place, and deduct the initial deposit submitted with the original offer. The remaining amount is the sum that you'll need to financed your purchase until the sale of your old home is completed.

It's normally a fairly easy and inexpensive way to facilitate the need, especially in a low-interest rate environment, and since the loan term is typically very short. Of course, the lender will charge a nominal administration fee, but the peace of mind provided in what is usually a stressful period of your life is worth the small expense.

However, it must be noted that bridge financing loans are typically offered for no more than 90 days, and only when ...

An unconditional Agreement of Purchase and Sale is in place for the borrower's existing property

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Bridge loans usually carry a higher rate of interest than a traditional mortgage. In addition to legal and administration fees, typically ranging from $250 to $500, interest rates, which vary by lender, are often the prime lending rate plus two per cent.

Why the higher interest rate? Because they carry greater risk for the lender. A home sale could fall apart before the transaction is officially completed, raising the risk that a buyer will suddenly be forced to carry two mortgages, as well as taxes and utilities, on the two homes. Oh my!

While the downside of bridge financing is minimal, there are some key considerations to keep in mind. The first is that buyers must financially qualify. It's not unlike applying for a regular mortgage loan; gross combined annual income and credit scores are important considerations for the lender.

Secondly, not all financial institutions offer bridge loans. Further, some high risk buyers may be forced to seek financing from private lenders who charge far steeper rates, currently as high as 19 to 21 per cent.

The worst thing you can do is to make a commitment to buy a home unconditionally, only to realize afterward when the dust has settled that you cannot be approved for a bridge loan because you don't have sufficient equity in your present property to secure it. Or just as bad, that you'll be unable to comfortably service the debt.

I strongly advise that you have a serious discussion with your financial advisor, be it a banker, lawyer or mortgage broker, and develop a feasible plan ... 

Before making any contractual commitments

In the event that a worst-case scenario happens, you'll not regret having been realistically prepared with a plan that takes into account everything from household cash flow, to excess funds from savings, to your ability to carry two mortgages. Hey - it's possible.

At the end of the day, a well-planned financing strategy, that may include a bridge loan, will provide you with peace of mind. I must emphasize again that your detailed plan should include a trip to your lender of choice, which is usually the same institution that is providing your mortgage loan.

For more information, visit The Real Estate Council of Ontario (RECO).

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