A mortgage is a massive financial commitment.
If you’re not sure you’ll be in the home you want to buy forever, a typical mortgage can appear daunting.
At some point, you may want to upsize or downsize your home.
Or, you may want to just move.
When you purchase a new home while you still have a mortgage, you’ll usually use your equity by transferring it to the new home.
This is completely fine and normal.
It’s a great plan when everything goes smoothly.
But there’s one potential problem.
What if you end up with inconvenient closing dates for the sale of your current home and the purchase of your new one?
When your current home’s closing date is after the closing of your new home, you’re in an odd situation.
If you’re relying on the equity in your first home for a down payment, you may have a serious problem.
There is one solution created specifically for this kind of conundrum: Bridge Financing.
How Does Bridge Financing Work?
Bridge financing is a loan solution designed specifically for “bridging” the gap between the two closing dates.
That way, you can still use equity from your existing home to finance your new home purchase.
You can then pay the bridge loan back once your first home’s sale is closed.
Bridge loans are short-term.
They have much shorter terms than other home financing options.
That’s because they’re meant exclusively for situations such as the one described above.
Most bridge loan terms range from 90 days to a full year.
The main qualification requirement for a bridge loan is having a formal sale agreement in place for your first home.
The lender will want to make sure your first home has serious prospects for closing sometime in the next year (or less).
Bridge financing is used by individuals and real estate professionals.
It’s most often used in areas with high competition over real estate.
Where sales are completed fast and bidding wars are common, bridge loans come in handy to ‘bridge the gap’.
With bridge loans, borrowers can make quicker decisions to close on a new and more ideal home without having to worry as much about the first home’s closing time.
Once the first home is sold, the bridge loan and its interest can then be paid off.
Mary and Jackson decided they want to move to a new home that’s larger to accommodate their growing family. They’ve already completed a sale agreement for their current home.
However, the home they’re trying to buy is in a very high demand neighbourhood, so the seller wants to close quickly and only deals with potential buyers that are aligned to this.
Mary and Jackson understand the situation, but their first home’s closing is set for November 30th which is after the closing time for their ideal new home, set for October 15th.
So, they get a bridge loan which acts as the equity from their first home, since they have not received sale proceeds from their first home yet.
They secure their new home and get ahead of the other potential buyers.
On November 30th, they pay the bridge loan lender back using the proceeds of their first home’s sale.
Pros of Bridge Financing
- You can buy a new home before selling your first one
- You have much more flexibility during the process of switching homes
- You can still use your first home’s equity to secure a down payment for your new home
Cons of Bridge Financing
- Bridge loans often have high interest rates and vary widely in cost
- Present higher risk if things don’t go according to plan, for example, if the sale of your current house falls through you’re in a tight spot
Other Areas Where Bridge Financing Is Used
Bridge financing is normally used in real estate.
But there are a few other applications.
Businesses sometimes use bridge financing when they are waiting for long-term financing to come in.
Like personal real estate, business loans can be very large.
When waiting for a large business loan to finance equipment, land, capital expenses, and more, bridge loans can fill the gap.
Business loans often take time to acquire, whereas bridge loans are meant to be fast and short-term.
As an example, think about a business that is planning some equity financing.
This can take a long time.
During the time before the company sells off its shares, the business may opt for a bridge loan to cover its operating (day-to-day) expenses.
The equity financing will then provide the business with its much-needed cash and allow it to pay back the bridge loan.
As is the case with personal real estate bridge loans, real estate companies can also take advantage of them.
Some real estate companies focus on hotly contested housing markets.
When time is of the essence and there is a lot of competition, a bridge loan can help the company acquire a great, new investment property faster.
Frequently Asked Questions
- What is the purpose of bridge financing?
- Are bridging loans a bad idea?
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Bridging loans present a unique risk to borrowers. They are short-term and often expensive. At the same time, repayment relies on a large source of income in the imminent future. If that source of income (home sale, other financing, sale of assets, etc.) is compromised, bridge loans become a serious liability.
It’s up to the borrower to assess the risks of taking a bridge loan. The more certainty there is that the bridge loan can be repaid very soon, the better. If the prospect of repaying a bridge loan is not realistic, then bridging loans are a bad idea.
