Timing is crucial when buying a new home and selling the old one. Imagine that you've found your dream home, but your current home hasn't sold yet. What should you do next?

That's where a bridge loan comes into play.

You can use the equity in your current home for the down payment on your next property while you wait for your home to sell.

Bridge loan terms can be as little as one day but typically go up to six months but can go as far as 12 months. To qualify for a bridge loan, a firm sale agreement must be in place on your existing home as this is what the bank uses to show where the funds are coming from.

This type of financing is most common in hot real estate markets where bidding wars are the norm. They work when you need to make a quick decision about your dream home without worrying if your existing home has sold.

How does a bridge loan work in Canada?

With a bridge loan, you don't have to make regular payments while waiting for your home to close. Depending on your lender, your loan will have interest-only payments during the duration of the loan or accrue the payments and require full repayment and interest at maturity.

The lender will have a real estate lawyer sign an assignment of proceeds of the sale, which states that the borrower will repay the full loan upon the sale of the home. Since bridge loans have short terms, they come with higher interest rates than standard mortgages.

Example

Suppose you have a 30-day closing date for your new home but expect to complete the sale of your current home within 90 days. This means you won't have the cash for the new home from the sale of your current home yet. In that case, your bridge loan will pay for and cover the 60-day gap.

If you own a $400,000 home and owe $200,000 on your mortgage, you may qualify for a $200,000 bridge loan. Once you sell your current home, the equity from that sale will go towards repaying your bridge loan. 

Keep in mind that bridge loans include closing costs and other fees. If there is a firm sale on the existing home, most major banks in Canada will go up to a 90-95% Loan-to-value ratio when offering a bridge loan. This allows you to use almost all of the equity available in your current home. 

However, most private lenders will not exceed a 75% loan-to-value ratio when offering a bridge loan. If you want a bridge loan, you'll have to maintain at least 30% equity in the current asset you own.

Loan qualification process

The qualification process for a bridge loan in Canada is similar to a mortgage application. Lenders will ask for proof of income, bank statements, and credit checks. You’ll need to apply from the same lender that provided you with your initial mortgage.

So: What's required for approval? Before approving your bridge loan, lenders need to see the Agreement of Purchase and firm sale for your current home, as well as one for your new home. Your financial institution may not extend you a bridge loan without both agreements. Banks may not lend you money without a sale agreement.

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