Bridge Financing | Financing Your Mortgage Between Homes
Table of contents
Bridge financing is a financial solution that helps individuals navigate the gap between buying a new home and selling their existing one. It provides temporary funds to cover the down payment on a new property while waiting for the proceeds from the sale of the current property. This article will explore the concept of bridge financing, how it works, its pros and cons, and how it compares to traditional loans.
- A bridge loan allows you to purchase a new home with a loan up to the equity in your previous home before its closing date.
- Bridge loans feature higher interest rates than traditional loans, but they are only available for short durations.
- Bridge financing can be calculated based on the equity in the current property and the expected proceeds from its sale.
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What is Bridge Financing?
Bridge financing, also known as a bridge loan or bridging loan, is a short-term loan that helps homeowners finance the purchase of a new property while awaiting the sale of their current property. It serves as a temporary source of funds to bridge the financial gap between the two transactions.
Bridge financing is especially beneficial in competitive real estate markets where timing is crucial. It allows homeowners to make an offer on a new property without the contingency of selling their current one first. This flexibility can give them a competitive edge, as it eliminates the need to wait for the sale before proceeding with the purchase.
How Does Bridge Financing work?
In essence, bridge financing in Canada allows you to access equity earlier than you should. The main qualification for a bridge loan is the confirmation of a buyer for your home. It should be noted that this loan type usually has a very short duration- as short as few days or as long as 12 months or more.
Hot real estate markets see a lot of bidding and haggling, and as a result, you could easily miss out on your dream property while waiting for your home sale to go through. Bridge funding is commonly used by homeowners in such markets to avoid missing out on desired deals. The bridge loan and interest accrued are then paid when you sell your home and access funds from there.
What are the Pros and Cons of Bridge Financing?
Bridge financing offers several advantages and disadvantages that homeowners should consider before opting for this financial solution. Let’s explore the pros and cons in detail:
Pros of Bridge Financing
- Financial Flexibility: Bridge financing provides homeowners with the flexibility to buy a new property before selling their current one. This opens up opportunities in competitive real estate markets and allows homeowners to secure their dream home without the constraint of timing.
- Quick Access to Funds: Bridge loans are designed to provide quick access to funds, allowing homeowners to move forward with their new home purchase promptly. This can be especially beneficial when faced with time-sensitive situations or when there’s a risk of losing out on a desired property.
- Avoiding Contingencies: By using bridge financing, homeowners can make offers on new properties without including a contingency for the sale of their current property. This makes their offer more appealing to sellers as it eliminates the uncertainty associated with waiting for a sale.
Cons of Bridge Financing
- Higher Interest Rates: Bridge loans typically come with higher interest rates compared to traditional mortgage loans. This is because they are short-term loans and carry a higher level of risk for lenders. Homeowners need to carefully consider the cost implications of the higher interest rates when opting for bridge financing.
- Additional Fees: In addition to the higher interest rates, homeowners should be aware of the additional fees associated with bridge financing. These may include administrative fees, origination fees, legal fees, and potentially a higher down payment requirement.
- Potential for Debt Accumulation: Bridge financing carries the risk of accumulating debt if the sale of the current property takes longer than expected. Homeowners should have a clear plan for selling their current property within the bridge loan term to avoid being burdened with additional debt.
Bridge Financing vs Traditional Loans
Mortgage bridge loans generally undergo faster processing especially since they are usually needed somewhat urgently. Compared to traditional loans, they see a speedier application, approval, and funding process. Given their nature, these loans typically feature high interest rates, short terms, and significant origination fees.
Since they are a short-term plan, borrowers still choose this option because it compensates by providing quick and easy access to funds. In addition, the high interest only accrues over a very short period and this can still be reasonable given the huge problem it solves. In addition, prepayment penalties are absent from most bridge loans.
|Traditional Mortgage Loans
|Short-term, typically 6-12 months
|Long-term, typically 25 years in Canada
|Bridging the financial gap between two properties
|Financing the purchase of a single property
|Higher interest rates due to short-term nature
|Lower interest rates over an extended period
|Faster approval process
|Thorough credit assessment and documentation required
|Based on equity in the current property and expected proceeds from its sale
|Based on the purchase price and borrower’s financial profile
|Repaid from the sale of the current property or through a mortgage on the new property
|Monthly installments over the loan term
One important detail to note is that the amount that you can borrow cannot exceed the equity you have in your present home.
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How to Calculate a Bridge Financing Loan
Using a bridging loan calculator for this works just great. Now, here’s a breakdown of what you need to know whether or not you would be using a bridge loan calculator in Canada:
Given a scenario where your home has a closing date about 100 days away and the new home has a closing date only 55 days away. The 45-day period (100 days – 55 days) would be covered in terms of equity by the bridge loan.
Take for instance that the price tag on the home is $450,000, you made an initial deposit of 5% ($450,000 x 0.05 = $22,500), and you’re looking to use all of the $195,000 equity you have in the home you put up for sale.
Since there is a disparity between the closing date on your new home and that of your old home, you would need a bridge loan to cover the difference between the intended total payment and deposit.
Using a bridging finance calculator:
$195,000 (deposit) – $22,500 (down payment) = $172,500 (bridge financing)
Additional Fees to Consider
The main fee that comes with a bridge loan is the interest, which often bears a rate similar to a personal line of credit or an open mortgage.
On average, this figure is around prime +1%, however, depending on amount needed and creditworthiness, it might soar to up to 8.5% or even 10.5%. This is somewhat reasonable when compared to business bridge loans that typically charge interest rates between 15% and 24%.
Alongside interest, borrowers also pay closing costs as well as necessary legal and administrative fees. Closing costs are required too for a bridge mortgage, and may range from 1.5% to 3% of the entire loan amount:
- Appraisal fee
- Administrative fee
- Notary fee
- Title searches
- Loan origination fee
Frequently Asked Questions
Do all lenders offer bridge loans?
Bridge loans are quite common, and as a result, can easily be gotten from lenders including all the big banks in Canada. You may be able to secure bridge financing from small lenders, however, ensure you have consulted with your mortgage broker.
Most banks do not allow access to bridge loans without your having a mortgage with them. This is because bridge loans as a standalone product bear more risk to reward for them. In the event that you are unable to access a bridge loan this way, you may need to opt for a private lender.
How much will lenders typically offer on a bridge loan?
A large loan from a lender is done on a case-by-case basis. The lender typically reviews the entire situation as well as your financial standing, however, this process might take longer. Your property might also see a lien registered on it, so, you would be looking at more in the way of fees, including legal fees.
Generally, lenders can lend up to $100,000 for a duration of up to 120 days without too much of a hassle. Loans like these do not usually see a lien registered on the property. As a result, it would be less expensive, although the bridging loan interest rate is somewhat steep.
What is the interest rate on a bridge loan?
The interest rate on a bridge loan is typically higher than that of traditional mortgage loans. The exact interest rate will depend on various factors, including the lender, the borrower’s financial profile, and the current market conditions. It’s important to shop around, compare rates from different lenders, and consider the overall cost of the loan before making a decision.
What are some alternatives to bridge financing?
If bridge financing doesn’t align with your financial goals or circumstances, there are alternatives to consider:
- Home Equity Line of Credit (HELOC): If you have significant equity in your current property, a HELOC allows you to borrow against it to finance the down payment on a new property. HELOCs typically have lower interest rates than bridge loans.
- Personal Loan: Depending on your creditworthiness, you may qualify for a personal loan to cover the down payment on a new property. Personal loans often have shorter terms and higher interest rates than traditional mortgage loans.
- Sale and Leaseback: In some cases, homeowners may consider selling their current property and leasing it back from the new owner. This arrangement provides immediate funds from the sale while allowing homeowners to continue living in the property.
It’s important to carefully evaluate each alternative and consult with a mortgage professional to determine the best option for your specific situation.
Bridge financing serves as a valuable tool for homeowners navigating the gap between buying a new home and selling their existing one. It offers financial flexibility and the opportunity to seize opportunities in the real estate market. However, it’s essential to weigh the pros and cons, consider the associated costs, and explore alternatives before opting for bridge financing. By understanding how bridge financing works and evaluating your financial objectives, you can make an informed decision that aligns with your needs and circumstances.
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