Happy Birthday to the Canada Mortgage Bond ProgramJune 20, 2011
Low Interest Rates a Ray of Sunshine On An Otherwise Cloudy Economic DayJune 27, 2011
More to the point, what do you do if you have to close the purchase of your new home before you complete the sale of your old one?
In these cases you need a short-term loan to access the money that will be coming to you from your sale. The solution, appropriately enough, is called bridge financing.
Today’s post will explain how bridge loans work for borrowers who are considering this option.
Let’s start by addressing the most common concern: If you need a bridge loan, it does not alter or limit your ability to qualify for a mortgage in any way. You don’t actually need to qualify for bridge financing using your income – the only requirement is that you have an unconditional offer to purchase the property you are selling. This type of loan is typically offered in addition to a traditional mortgage loan – your lender simply lends you the money that will be coming to you when your property sells as a way to help facilitate the overall transaction.
Here is a simple example of how a bridge loan works (and here also is a link to my Bridge Loan Calculator so that you can follow along using your own specific details):
Assume you have just accepted an unconditional offer to purchase your current property on October 30. After paying off your mortgage and covering your disposition costs, you will be left with net proceeds of $180,750 (see item A).
You then buy a new property, but the sellers want you to take possession on October 12, which is 18 days before you will complete the sale of your existing home.
After making a $35,000 deposit, you decide to use an additional $130,750 (see item B) of the net proceeds from the sale and get approved for a $409,250 mortgage to cover the rest. (Note: in this example you decide to hold back $50,000 of the $180,750 coming to you from the sale for closing costs and minor renovations).
You need that $130,750 on October 12, but you won’t receive it from your buyer until October 30. As such, your mortgage broker helps you secure an 18-day bridge loan at prime +3% (6% in today’s terms) at a total cost of $598 (see item C). Problem solved.
Lenders typically expect a gap of no more than 30 days between your buy and sell dates, although bridge loans for longer periods may be offered by some lenders on an exception basis.
Bridge loan rates are always higher than traditional rates because they are unsecured, short term, and because the lender is basically lending you the entire purchase price of the house during the bridge-loan period. You should expect to pay somewhere in the range of prime + 2% to prime + 4%, which works out to 6% to 8% in today’s terms (some lenders will also charge an application fee of approximately $250).
Keep in mind that, on balance, your bridge loan rate will have far less impact on your overall financing costs than your mortgage rate because it only applies to the bridge-loan amount and during the bridge-loan period. (In the example above, the bridge loan of $130,750 with a rate of 6% only costs the borrower $598 over the 18-day period.) The key point is that bridge loans maximize your flexibility when selling.
If you have borrowing room on any existing lines of credit, most lenders will ask you to draw down these lines first, before then bridging the remaining gap.
On the day you complete the purchase of your new home, you will be required to sign a Letter of Direction and Irrevocable Assignment of Funds. This is a promise to use your net sale proceeds to pay off the lender’s bridge loan before taking any money for yourself. On larger bridge loans your lender may go a step further and require that a collateral charge be registered on the property you are selling (this adds some cost but achieves the same end result).
While not all lenders offer bridge financing, an experienced, independent mortgage broker will have access to several who do.
The Bottom Line: Instead of worrying about lining up your closing dates on the same day and trying for perfection in an imperfect world, consider bridge financing as an easy and cost-effective way to increase your flexibility when your buy and sell dates don’t overlap.