What is a bridge loan and how does it work?
Timing is crucial when buying a new home and selling the old one. Imagine that you've found your dream home, but your current home hasn't sold yet. What should you do next?
That's where a bridge loan comes into play.
What is a bridge loan and how can it help you? That's where we're here to explain!
What is a bridge loan?
A bridge financing or loan allows you to carry the mortgage for two properties that typically last for 90 days. The loan gives you the time to bridge the gap between closing on your current property and moving into the other.
How does a bridge loan work in Canada?
A bridge loan in Canada usually has a 90-day period. With a bridge loan, you don't have to make regular payments while waiting for your home to close. Depending on your lender, your loan will have interest-only payments during the duration of the loan or accrue the payments and require full repayment and interest at maturity.
The lender will have a real estate lawyer sign an assignment of proceeds of the sale, which states that the borrower will repay the full loan upon the sale of the home. Since bridge loans have short terms, they come with higher interest rates than standard mortgages.
Example
Suppose you have a 30-day closing date for your new home but expect to complete the sale of your current home within 90 days. In that case, your bridge loan will pay for and cover the 60-day gap.
If you own a $400,000 home and owe $200,000 on your mortgage, you may qualify for a $200,000 bridge loan. Once you sell your current home, the equity from that sale will go towards repaying your bridge loan.
Keep in mind that bridge loans include closing costs and other fees. If there is a firm sale on the existing home, most major banks in Canada will go up to a 90-95% Loan-to-value ratio when offering a bridge loan. This allows you to use almost all of the equity available in your current home.
However, most private lenders will not exceed a 75% loan-to-value ratio when offering a bridge loan. If you want a bridge loan, you'll have to maintain at least 30% equity in the current asset you own.
Loan qualification process
The qualification process for a bridge loan in Canada is similar to a mortgage application. Lenders will ask for proof of income, bank statements, and credit checks. You’ll need to apply from the same lender that provided you with your initial mortgage. Since you’ve already applied with your lender, they should already have all your information.
The big question is: What's required for approval? Before approving your bridge loan, lenders need to see the Agreement of Purchase and firm sale for your current home, as well as one for your new home. Your financial institution may not extend you a bridge loan without both agreements. Banks may not lend you money without a sale agreement.
What are the pros and cons of bridge financing in Canada
As with any financial decision, bridge loans have their advantages and disadvantages.
Pros
- They allow you to put a sizable down payment on a new home before selling your old home.
- After taking possession of your new property, you can stay in the old home to complete renovations.
- You pay the loan back after you close on your home, offering more flexibility.
Cons
- Bridge loans have a short lifespan, with high-interest rates of prime plus the current interest rate and depending on your application.
- The lender may use a variable prime rate, which means your interest rates can suddenly change.
- Your home may not close, which could lead to difficulties paying back the loan.
Worries about your home not selling? Learn about our Sale Assurance!
How long can you bridge a mortgage?
Lenders typically offer bridge loans for 90 days but can extend them. If you require a larger loan or a longer repayment period, the lender may agree to assess your situation on a case-by-case basis. While bridge loans don't need a lien (legal right for property seizure to pay back debt), different terms may cause the lender to place a lien on your property.
Alternatives to a bridge loan
If you're planning on obtaining a bridge loan, you may want to consider other alternatives to keep your options open.
Home equity loans
Homeowners who need cash but don't want to sell their homes can apply for a home equity loan. A home equity loan, also known as a second mortgage in Canada, refers to a loan taken out on a home with an existing mortgage. Your home will serve as collateral for both mortgages, meaning the banks or lenders may foreclose if you fail to pay.
Home equity line of credit (HELOC)
A home equity line of credit, or HELOC, provides a secured line of credit. The lender will use your home as collateral to guarantee you will repay the loan. Homeowners that need a large amount of money should apply for a HELOC, as it allows you to borrow up to 80% of your
Personal loan
A personal loan involves borrowing money you agree to pay back over time. It's your responsibility to repay the entire amount of the loan, including any interest and applicable fees. Most people use personal loans to consolidate debt or finance purchases like home renovations or cars.
Going with Properly!
Hopefully, you can now answer, "What is a bridge loan?" At Properly, we want you to know what the home buying and selling process entails, from acquiring bridge loans to financing mortgages.
Contact Properly today and speak with a mortgage advisor about how we can help you!
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