What Are Bridge Loans
Bridge loans by definition are a sum of money provided by a bank or investor to cover the gap between two transactions. The most common use for bridge loans is to aid the process of buying one home and selling another when timelines aren’t favourable. If there is an urge or a need to buy a home before selling your existing one, then a bridge loan is exactly what you need.
Risks involved with bridge loans
There are two main risks to be aware of when taking out a bridge loan. The first is type is called a compounding risk.
The longer it takes to sell the existing home, the more leveraged the home owner becomes. If houses are selling at a lesser value, it will become tougher to pay off both the previous mortgage and bridge loan.
The second type of risk is time and cost. Typical bridge loans have a 6 month period. If you are unable to sell the previous home during that period, you will be required to refinance the bridge loan which will typically be more expensive. Bridge loan interest rates are 2-3% higher than your average mortgage rate.
Benefits of bridge loans
Don’t let the risks of taking out a bridge loan scare you, it is simply to educate and prepare you for the process.
The whole juggling act of lining up closing dates of your current home and new home can be quite a hassle. Factor in moving, your family, dog, you name it – and you now have quite the headache.
Don’t forget the big kicker – renovations. Unless The timing works out perfectly, which hardly ever happens, you might have 2-3 weeks of work being done to your new home. You can post up at a hotel or family members home as an option, or take out a bridge loan and stay in your current home longer.
Example of a bridge loan
I’m going to walk through an example of a bridge loan with real numbers so you can take an in-depth look at the actual costs involved.
In this example we’ll use a couple that sold for $400k. Closing is November 1. There is an existing mortgage of $250k. They bought another house for $600k. Closing is November 22. They will spend $50k in renos for a new kitchen and bathroom. They want a $450k mortgage to cover renos, closing costs and take out some money for personal use. Here’s how the Bridge loan works:
- Bridge loan amount would be $150k… we calculate this by taking the Purchase price ($600k) less the new mortgage amount ($450k).
- Rate of interest will vary but it’s around Prime plus 2.00% (today’s prime rate is 3.00%).
- Lender admin fees range from $250 to $500.
- Legal fees vary depending on Lender and Lawyer… $200 to $400.
- Interest costs are $20.55 per day. Total interest would be $287.70.
- Overall total cost of the Bridge Loan would be between $737 and $1200 depending on your lawyer’s legal fees and Lender admin fees.
Qualifications and limitations when getting a bridge loan
- Most banks don’t offer bridge loans because of the low profit margins. They also don’t like the idea of your possibility of your existing home not closing. There is very limited exposure and risk for the bank, so its not a popular option.
- Only the mortgage provider of your new home will offer you a bridge loan.
- Your lawyer will be required to help complete the deal. They need to provide an undertaking to register a mortgage in the rare occurrence of your existing home’s sale collapsing.
While not all lenders offer bridge financing, an experienced, independent mortgage planner will have access to several who do. So instead of worrying about lining up your closing dates on the same day and trying for perfection in an imperfect world, use bridge financing as an easy and cost-effective tool when coordinating buying and selling transactions.
It’s very clear that the benefits outweigh the small risks associated with bridge loans vs the hassle of moving in a small timeframe and trying to make everything line up perfectly. The average costs, of course depending on the value of each home, is about $700 – $2,000. Having the option to take that and use a few weeks to clean up, move things in slowly and renovate is worth it to me.