I recently received an email from a potential client asking these very questions:
“I was wondering how the process usually goes, for looking at a new place. We had planned to use our equity in this home as the down payment for a new place. But if we can’t unlock that equity until the closing date, what usually happens in the interim? Do we have to find a place to rent?…a month or longer? When we bought this place, it was our first home purchase, so moving to a new one is new to us. I don’t understand how we are supposed to start looking for a place after subject removal (which is 30 days after tomorrow), when we can’t access the equity to make a down payment.”
This scenario happens much more often than one thinks. In order for sellers to access their equity to become buyers they are required to utilize a bridge loan to transition into their “next” home. The bridge loan allows you to purchase a new property before the sale completes on the existing or current residence.
Most lenders have a 45 – 60-day window to exercise this option, with a range of daily rates and admin fees. The four vital components to a mortgage application are income, credit worthiness, the subject property and down payment.
The first three have been approved; now how does one unlock the down payment? Easy. The borrower is required to supply the fully executed purchase and sale contract, subject removal addendum and the current mortgage statement for the existing property. This provides confirmation that you have sold the property on X date as well it confirming the sale price less the possible real estate commission fees and closing costs. Once the current mortgage amount is subtracted the net proceeds are yielded, leaving you your down payment amount.
As mentioned above, there are fees to access bridge financing, as well as a daily interest rate. If the purchase of the next property completes the same day as the sale, then it is handled at the lawyer’s office internally and the funds are transferred accordingly.
The equity is yours to access right now. The lenders verify your equity with the conditions provided.
Here is an example of the timeline and fees of how the bridge loan scenario can be utilized:
Existing home sold, completing December 14, 2016 $600,000
Current outstanding balance $400,000
Equity remaining $200,000
New home purchase, completing November 30, 2016
The lender has approved the down-payment amount. Because the proceeds are still secured against the existing home we had to provide confirmation that the funds were available. We determined there was $200,000 by way of sales contract, subject removal addendum and the current mortgage statement.
The second layer to the bridge loan is the cost of borrowing the $200,000. Bear in mind the funds are still tied up in the existing property. The cost to borrow the $200,000 temporarily is Prime + 2% (daily rate) plus an administration fee of $250.
$200,000 x 4.70% / 365 (days) = $25.76 per day to borrow $200,000
There is a 14-day completion difference. The total cost to utilize a bridge loan is $360.64 (in interest) + $250 (admin fee) = $610.64.
All-in-all this is a very inexpensive and easy way to access the equity you have built up in your current home. Remember, lenders are in business of making money…this is simply a cost of doing business.
Be sure to surround yourself with industry professionals (like the mortgage brokers at Dominion Lending Centres) to make sure nothing is overlooked or miscalculated.