A bridge loan is a short term loan meant to “bridge” the financing gap between the time a borrower buys a new home and selling the existing one.
This temporary shortage of funds is caused due to the lengthy time needed from the moment a house is listed for sale until the proceeds of the sale is made available to the seller.
Household often make the conscious decision to purchase a new home before taking concrete steps to sell the existing one because of simple housing management.
Should a homeowner sell the existing house before getting a new one, he faces the prospect of being homeless should he be unable to find a suitable new home before having to vacate the existing home for the new owner.
Should this event happen, the homeowner might have to inconveniently house his family at a relative’s house or spent money on living in a hotel.
By buying before selling, he also avoids the prospect of having to buy a new home out of panic and desperation.
Sometimes also known as a bridging loan, a bridge loan solves a real world problem commonly faced by regular households.
If the deal involves a mortgage, at closing when buying a new home, the buyer obtains a mortgage approval on condition that the existing house is sold within a specified period of time.
Even though a contract to sell needs to be reproduced for verification with the lender, deals can still collapse for various reasons.
The bridge loan is then tied to the whole deal.
This is a requirement by the lender as the presence of an existing property, together with it’s existing mortgage, can vastly affect the loan quantum and loan to value of the approval.
In fact, often times a borrower will not be able to obtain the required amount of loan quantum and LTV should he retain the existing house.
If a new mortgage is not required for the deal, then the borrower signs up for a straight up bridge loan.
The term of such a loan is short term and usually stretches between 3 to 12 months. And it comes with pretty high interest rate.
But because of the short tenor and the funding is absolutely necessary for the deal, borrowers usually see it as a cost worth paying for.
At closing for the purchase of the new home, funds for the bridge loan is disbursed.
When the proceeds of the sale of the existing house is ready, it is used to fully pay off the bridge loan.
All parties walk away from the deal happy.
The borrower gets to buy a new home and sell the old one, the seller of the new home gets the proceeds from his sale, and the lender banks in a tidy profit while helping their customers purchase their dream homes.