Bridge financing explained

Bridge: “A structure spanning and providing passage over a gap or barrier.”

Imagine the world without bridges – it would certainly make the commute to work a whole lot more interesting! We sometimes need financial bridges too – especially when it comes to real estate.

Bridge loans provide temporary funding when you buy a new home before selling your existing home. They “bridge” the gap between two different closing dates.

If the closing date on the house you purchased comes before the closing date of the house you’ve sold, you’ll probably need bridge financing, since you won’t be able to use the cash from the sale of your house until that deal closes. A bridge loan funds your downpayment in that interim period.

Of course, once your house sale closes, you’ll be able to pay off the bridge loan and get on with enjoying your new place!

An Example of a Bridge Loan

There is a fair amount of confusion surrounding bridge financing, so we’ll use a simple example to give you a clear idea of what bridge loans do.

Let’s say you buy a new house and the deal closes on November 1. You then sell your current house, with a closing date of December 1. Unless you have extra money lying around, you’ll need bridge financing for 30 days to cover your downpayment until you receive the proceeds from the sale of your home.

So, in our hypothetical situation, your bridge financing would extend from November 1 to December 1, or 30 days.

Standard bridge loans are calculated simply by taking your downpayment amount and subtracting whatever deposit you’ve already paid. The math is pretty simple: let’s say you bought your new home for $500,000 and your downpayment is 20%, or $100,000. If your deposit was $25,000, you’ll need a bridge loan for the remaining $75,000 on closing day. Once you receive the proceeds from the sale of your old home on December 1, you’ll be able to pay the bridge loan off.

The loan has covered, or “bridged” your gap in funding until your old house closes.

Bridge Loan Costs

So what does the bank get out of bridge financing? Well, for starters, they levy a fee for processing the loan, typically ranging from $300 to $600.

Banks also charge substantially higher interest rates for bridge loans than standard mortgages. Rates are usually based on the prime lending rate plus whatever margin the bank is charging. Lately the rates have been Prime + 2.00%, or an effective annual rate of 5.00%. Some banks charge more.

Tips and Tricks

Find out early in the home buying process if your lender will even provide a bridge loan. Smaller mortgage lenders in Canada often don’t offer bridge financing, and the banks that do usually only extend bridge loans if they are funding the mortgage for the new home. You don’t want to be in the unpleasant situation of shopping around for another lender at the eleventh hour.

There could be some administrative hassles along the way too. Your bank will want to see the Agreement of Purchase and Sale for both the house you’re buying and the house you’re selling. You need to have firm offers on both properties to qualify for bridge financing.

The bank will also review the existing mortgage on your home to make sure you have enough equity to pay off the bridge loan once you sell your house.

Keep in mind also that most bridge loans are limited to 90 days, so you’ll want to make sure you close the deal on your existing house relatively quickly.

You’ll also probably have to pay extra legal fees because of the additional work required to register the title.

Wrap-Up

If you’re moving up the property ladder, bridge loans can be a great financial tool. Closing dates don’t always align and bridge financing will cover the gap between the purchase of your next house and the sale of your previous house. Just make sure you set up your bridge loan well ahead of time so you can get the best rates possible and minimize your financing hassles.