Bridge Financing Basics
You’re looking for your next home, and walk into the place of your dreams. The space is tailor-made, the location is perfect, even the price is right. Just one problem: the owner of your dream home has to close the deal within the month, and you can’t sell your current home that quickly. How can you come up with the money to buy the new place, while carrying the old one?
Bridge financing could be your best way to seal the deal. This type of financing is a hefty short-term loan that bridges you over the period when you own and are paying for two homes.
To obtain bridge financing, you have to present your financial institution with two firm offers – one for your current house and one for your next home. You should be able to obtain financing of 80 percent to 90 percent of the value of your equity in your current home in the form of a mortgage. You use it to finance the purchase of the new home and carry the two mortgages during the overlap period, before the sale of your current home closes.
Once that happens, you use the proceeds of the sale to pay off the bridge loan, plus interest and costs. Alternatively, you can arrange to repay the bridge loan in six months to a year. This may be useful if you need to save a bit to pay off the bridge in full.
Trouble is, the costs of bridge financing can really add up:
- interest on this type of short-term loan is relatively high, usually the prime rate plus one to three percent.
set-up fees can be hundreds of dollars
- you may have to pay up to six months’ worth of interest in advance for bridge loans that are structured to allow you a year or more for repayment
- you may be required to set up and pay for new mortgages on your old home and your new one, and use both homes as collateral against the debt
- worst-case scenario: the deal for your old home falls apart at the last minute. If that home is collateral for the bridge loan, the bank could seize it
The bottom line is you should only consider a bridge loan if you can afford the interest charges and can pay it off in full as soon as possible. With this type of financing, every single extra day can cost you hundreds or even thousands of dollars.