No Troubled Waters Ahead: What is a Bridge Loan and How Does it Work?
So you’ve sold your place and found the new home of your dreams. The problem? You need to buy before your sale has completed. This can happen for any number of reasons (maybe it’s competitive pressures and the only way to get the seller to accept your offer, or maybe you’re trying to time everything so you have some room for renovations) but it begs the question – what do I do next?
What you’re going to need is a Bridge Loan, and it’s pretty much exactly what it sounds like – a bridge of funds between your purchase and your sale so that you can complete on the new purchase.
A few facts about bridge loans:
-Many lenders offer this service, but not all do
-The service is not free (there is usually a bridge loan administration fee and an interest carrying cost)
-A bridge loan is ONLY available if you have a firm and binding accepted offer with subjects removed on the sale of your current home (having an offer with subjects pending or the realtor telling you it’ll be sold in a week is not sufficient collateral to qualify for this type of financing)
The last one tends to stump people the most, but the reason for this is simple: the bridge loan is essentially a short-term ‘demand’ loan with a set start date and end date. In many cases it is registered on title at the lawyers and the lawyer is responsible for paying out the bridge loan when your sale finally completes. So, if you don’t have a firm offer on your property, there’s no guarantee that you’ll be receiving funds and there are no set dates for the lawyer to work with, right?
The next question I usually get asked is then, “what do I do if I want to buy before I sell?” The answer is simple: you need to qualify for the mortgages on both properties. Usually lenders will look at converting one of the properties to a rental and using proposed rent, but ultimately you’d need to have enough income to cover the cost of both debts, in addition to all of the property expenses.
Also, if your down payment is coming from your existing property you may need to look at refinancing your current mortgage to access the down payment, so in essence, you’d have your current mortgage, the refinanced portion for the down payment, and the new mortgage to debt service and you’d want to ensure that you feel comfortable with your cash flow covering all of those payments just in case your current home takes awhile to sell.
Example of a bridge loan:
You’ve sold your home for $950,000, closing June 15th. You have a mortgage outstanding of $400,000. After realtor fees/other costs you anticipate that you will net about $500,000 to put down on the next property. You make an offer on your dream home for $1,100,000 and it’s accepted but only if you take a closing date of June 1st. You have funds for your deposit so you’re not worried about that piece of it, but how is the rest of it going to work?
For the period between June 1st and June 15th you will have:
Current mortgage $400,000
New mortgage $600,000 (purchase price minus $500,000 down) at negotiated contract rate
Bridge loan $500,000 (down payment, plus you can add in costs like property transfer tax, etc) at say prime plus 4% with a $250 fee
It’s important to remember that there is a cost to you, as all 3 of the above will be accruing interest for the bridge period. Bridge loan rates and fees vary considerably but I’ve included a rate for illustration purposes.
Quick calculation for the above: the cost on the bridge would be around $1300 (based on current prime rate) plus the fee, plus the interest you’re still carrying on your old mortgage. Make sense?
Lastly, a bridge loan is NOT a Deposit Loan. A deposit loan is unsecured funds advanced to you so you can put down a deposit on your purchase and there are many consumer lending companies and financial institutions that offer these short-term solutions. Alternatively, some people choose to use their own creditlines, credit cards, savings, or even a short term loan from family for the deposit.
Why is the deposit loan even necessary? The purpose of a deposit loan is to clearly show the seller of the home you want to buy that you’re serious. A deposit loan demonstrates intent, and in competitive markets like today’s market, you’ll often see larger deposits being offered to sweeten the deal – because if you decide to breach the terms of the contract that amount of money is forfeited to the seller as a type of ‘insurance’ for accepting your offer in good faith. With no deposit down, the buyer has no ‘skin in the game’ and the seller has nothing to fall back on should the buyer decide to change their mind and walk away.
Questions? Let’s talk.