What are Bridge Loans & How Do They Work?

Buying affordable homes in the sizzling real estate market is not a cakewalk, especially if you reside in Canada. At some time in life, you may feel to upgrade or downsize, or simply switch your home locations. And, you have to plan for the difficult and the worst! 

Think of a scenario where you wish to sell your current home and use its proceeds towards the purchase of a new house. What if, the closing dates don’t align, you get stuck in an awkward situation where the selling and buying dates of both the properties don’t overlap. What to do now?

As much as we would all like to pull the Cash Discount Program trick out of our back pocket, and save all that interest money by paying cash, unfortunately that just isn’t possible in the majority of cases.

So, the down payment for your new home is tied up in equity in your existing home. Now, how to handle this precarious matter? A Bridge Loan comes to your rescue and helps you manage the two properties concurrently.

What is a Bridge Loan?

Bridge Loan is a temporary short-term loan that borrowers take to bridge the gap between the time they sell an old property and buy a new one. Or you can say, you are bridging the gap between two financial transactions, your old and new mortgages. 

You simply need a copy of the Sale Agreement (existing home) and Purchase Agreement (new home) or a firm relevant offer, as applicable.

Lenders typically lend up to $200,000 for 120 days easily without a lien on your property. Beyond that, if you require a larger amount and for a longer duration, you may have to meet additional formalities and cost along with some collateral.

How does Bridge Financing Work?

Generally, the interest rate on a bridge loan is the Prime rate+ 2% or Prime Rate+3%. On top of it, you will also have to bear an administration fee that ranges from $200 to $500.

Let’s say, Current Home (sale) closing date is 90 days away, whereas the New Home (purchase) closing date is approaching in 30 days only. So, a bridge loan shall cover the differential period of 60 days (90-30) within the two dates. You can fund the purchase of your new house without waiting for the sale of the old one.

Buying a House Before Yours Sells: Does Bridge Loan Help?

Also, referred to as interim financing, a bridge loan is an effective tool to finance the purchase of new property while your old house is getting sold. You may also remove the contingency to sell, and move ahead with the purchase if the lender agrees so.

An obvious downside of a bridge loan is its high-interest rate as compared to normal mortgage rates. Since it is for a smaller period only, it won’t matter much.

However, it may not be necessary to utilize this option. But, in case you do, pay attention to all the terms, and watch for any penalties. If the old property doesn’t sell within the stipulated time, or you find it difficult to unload your house? Something to worry about!

But, when you know there’s going to be a lag in closing dates, you may not have a choice. A Bridge Loan can act as a borrower’s safety net but with hidden risks! So, discussing this with your mortgage broker is a great idea.