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Bridge Financing 101

Bridge Financing 101

In today's hot Toronto condo market , buyers and sellers can be caught homeless for a few weeks (or even a few months) in between properties, i.e. they sell their current condo but it takes longer than expected to find a new home due to the major listings constraint we're working under. The closing date on their new home ends up being later than the closing date of their current home.

There is another scenario, however, where the situation is reversed - a buyer needs to close on their new home before their current condo sale has closed.

Often times, this is because the new home that they're bidding on has a short closing period and they're not in a position to dictate terms. If you're starting to look for houses or condos for sale in Toronto , you'll know that it's a seller's market and you often have to cater to the seller's preferred terms to win a bid; that includes what could be a very short closing period.

There's also been a surge in buying before you sell activity in recent years; not surprising, given the conditions of the current GTA market. It's important to talk about this scenario with your Condo PRO and your lender / mortgage broker going into your property hunt so that you're prepared for any scenario and in a strong position come offer night.

Here's a quick overview on how a bridge loan can help when your sale and purchase dates don't align.

What is Bridge Financing?

Bridge financing or a bridge loan is literally your financial "bridge" to take you from your current property to your new home before the deal on your existing home closes.

In this situation, you're not liquid going into your new home as most buyers are and so you need a loan to cover the crossover period. When your current home sale closes, the amount owed is paid back in full directly from the proceeds.

Bridge financing is necessary in situations where you technically own two properties simultaneously. Your lender may allow this to happen and finance you to be able to carry both properties for a short and predetermined period of time.

What Are Some of the Reasons People Opt for Bridge Financing?

I'm sure there are additional examples but most often, bridge financing is required when you fall into one of the following categories: ---You want an extra week or two to move your things from your current property directly into your new home without having to rush and do it all in one morning. ---You need to be moved into your new place earlier for the start of the school year, in time for the holidays or the start of a new job and weren't able to negotiate an earlier close on your existing home. ---You want to do renovations on your new home before moving in. ---You want to ensure your offer on a new home is strong which means little or no conditions, including catering to the seller's preferred closing date (which may be before the closing date of your current home, particularly if yours had an extra long closing period). ---You're looking for a rare property that doesn't come up often in this market (e.g. an authentic, hard loft or a 3 bedroom condo) and so you opt to buy before you sell so that you don't end up homeless for months in between home transactions. ---You hadn't intended on starting your search just yet (therefore haven't listed your current home) but your dream home was just listed and you don't want to miss out.
In these last few situations, not all lenders will approve you for a bridge loan if you haven't already sold your current condo. In fact, many won't.

This is clearly the riskiest scenario (buying before you sell) but some clients opt to do this. If this applies to you, you should absolutely approach traditional lenders for bridge financing options in advance of offering (and make sure that you fully understand the risks) but note that it may be easier to secure a private loan.

For the purposes of today's post, we're going to focus on the other, more common scenarios where someone would want to secure bridge financing and that's if they've already sold their current place and are about to offer on a new home with a shorter closing period.

How Much Does Bridge Financing Cost?

Typically, a bridge loan will be prime plus 3% or 4% in today's market but it will vary from lender to lender. They are more expensive than a traditional mortgage but as they're only for a short period of time, the costs are actually very reasonable.

Bridge loans are often comparable to the cost of borrowing on your line of credit (which of course is another option for bridging the gap between two properties but you may not have a high enough limit).

There is also an administrative fee on top of the interest which is not a lot - usually $500 or less.

Remember, though, it's not just the loan costs you need to factor into your budget. It's the other carrying costs such as property tax, utilities and maintenance fees, if applicable, that can add up over the time of owning two properties; but if it's just a matter of a few weeks, costs should be reasonable.

Will My Bank Offer Bridge Financing?

A bank doesn't have to finance anyone but they want to keep your mortgage business and they know that if they don't, someone else likely will. And so if you're in good financial standing, have never missed a mortgage or any other type of loan payment with them and the sale of your current place has firmed up, chances are you'll be approved.

As with any loan though, it's all about perceived risk. You still have to qualify for a bridge loan and just because you have a mortgage with a lender, doesn't mean you're guaranteed any additional loans, particularly if your situation has changed since your original mortgage application and it's impacted your credit score negatively.

To formalize a bridge financing agreement, you will need to give the lender a copy of the Purchase & Sale Agreement for both your current home and your new home but obviously you'll want to start this conversation before offering on a new home so that you know what your options are in advance.

Alternatively, some buyers go ahead and offer without pre-approval and add a "conditional upon financing clause" but know that this may not win you the bid in a multiple offer situation. What you most definitely don't want to do is to put in a firm, no condition offer before sorting out your finances.

As with a first time condo buyer whom we always advise gets mortgage pre-approval before offering, so too should a client who's both selling and buying have bridge finance conversations in advance with their lender.

How Much Can I Get & For How Long?

Your bridge loan amount will be the cost of your new home minus the value of your mortgage and deposit. This number is the amount you need financed through a bridge loan until the sale of your current home is complete.

Another way to calculate it is to simply look at your down payment minus your deposit. So, for example, if you're buying a $500,000 property and your mortgage is $400,000, your down payment would be $100,000 which is a typical 20% down payment. If your deposit is $20,000, the remaining $80,000 is the amount you need a bridge loan for.

Many lenders will allow you to add closing costs to your bridge loan, providing you have enough equity in your current home and the purchaser's offer is firm. This means that you're a relatively safe bet in terms of your ability to repay the bridge loan in full upon closing of your current home. This is really helpful for buyers who have a lot of home equity but not a lot of liquidity in terms of cash in the bank.

Most bridge loans are for less than a few hundred thousand dollars and so if you calculate the payments on that - even at what's considered a "high" rate in today's market like 5% or 6% - you can see that the interest costs for borrowing over a short period of time are really quite nominal in the big scheme of things. Most clients are paying anywhere from a few hundred to a few thousand dollars to bridge, depending on the amount borrowed and duration.

In terms of duration, banks will typically bridge finance for up to two or three months but there are situations where a lender may offer a bridge loan for 120 days or longer depending on their policy. 90 days is the typical max in Canada, however, so this is not a financing product that's meant to carry a new home purchase indefinitely.

What Happens if the Deal Falls Through?

And here's where the real risk lies. If you close on a new home and the sale of your current condo fails to go through on day of close, you still own two properties until the legals are sorted with your buyer and/or you're able to close with a new buyer.

Many lenders will simply extend the bridge loan period to allow you extra time to re-sell your condo; make sure that you're in a position to handle this worst case scenario before you lock yourself into a bridge loan.

Along with your mortgage payments on your old home and the bridge finance loan on your new home, you're responsible for taxes, maintenance fees if applicable and all the other bills that go along with property ownership on both homes.

You will most likely get compensation for that from your original buyer (sometimes it's getting to keep the deposit, other times a seller gets even more for their loss) but this can take awhile to work through the legals and so don't expect to have that cash in hand immediately.

The truth is, there is always some element of risk in real estate that a deal will fall through on day of close. The main reason this happens is when a buyer makes an offer and allows it to firm up even though they didn't get mortgage pre-approval and then they find they can't secure financing.

This is rare but it's not out of the realm of possibility - particularly with so many active first time buyers in the market - so make sure to speak with your mortgage broker or lender about what would happen in a situation like this.

What if I Can't Get Approval?

Offer night is approaching on your dream home but your lender has denied your bridge financing request. Your best options are to either:

a) quickly re-negotiate the close of your current condo sale. Your Realtor will call the buyer's Realtor to say that you're offering on a home with a shorter close and would they consider bringing their closing date forward (if it's a yes, they'll quickly get the contract dates amended and signed by both parties), or

b) ensure a really strong offer in every other aspect but include the longer closing date as non-negotiable. Of course with this option, you risk losing in a multiple bid situation but it is what it is. Another great home will come along in time should you lose this one.

If you're negotiating a bridge loan well in advance and not under the time crunch of an impending offer night, then you have more time to explore other options.

Private loans are one option (they may be easier to come by but you'll pay a steep rate) as is approaching alternative lenders for a new mortgage + a bridge loan. We always advise clients to take a hard look at their current mortgage terms and rate before porting and so now is a good time to do that anyway. If you're switching lenders, you'll have more negotiation power as a prospective client.

If, however, the fees to break your current mortgage are astronomical (as they often are with the big banks in Canada), then your lender pretty much has you where they want you; yet another reason why it's so important to play hardball in mortgage negotiations . Remember, mortgage terms are more important than saving a tenth of a percentage point on your interest rate.

Bridge Financing, Relatively Low-Risk

Bridge financing seems scary at first glance - the prospect of owning (and carrying) two properties at once - but it's actually quite inexpensive and may just give you the edge you need to win a bid and/or relieve the pressure of having to move out and in all in one day.

It's certainly worth a conversation with your lender and your Realtor; chat in advance of offering on a new property so that you're not under the time crunch and pressures of a multiple bid situation.

Condo images featured throughout from this week's featured listing: 156 Portland, Unit 517.

Lead image: Bridge made of coins, © Maxim S Pometun from Shutterstock.