Real Estate: The Real Dangers of a Bridge Loan

A bridge loan is a financing option that allows homebuyers to bridge the cash flow gap between the purchase of a new home and the sale of their current residence. 

This partial advance from a bank on the sale of your home allows you to quickly secure the property you wish to purchase without having to wait until you’ve sold your current home. However, this arrangement involves risks and requires borrowers to exercise caution.

What is a bridge loan, and what are the different types available to homebuyers?

A bridge loan is a short-term loan granted for a term of 12 months, generally renewable once. The loan amount represents between 60% and 80% of the appraised value of your current home. Among the financing solutions offered, there are three types of bridge loans.

First, a "dry" bridge loan is granted when the sale of the original property fully covers the cost of the new purchase, and no additional mortgage is needed. The borrower repays only the interest on the bridge loan until the property is sold.

Next, the associated or backed bridge loan—also known as a coupled or paired loan—is the most common type of bridge loan. It is offered when the price of the new property is higher than that of the property being sold. In this case, you must take out a traditional mortgage to finance the purchase. The monthly payments on your mortgage and those on your bridge loan are combined into a single monthly payment.

Finally, a bridge loan for refinancing is an attractive option when you want to purchase a new property before you have finished paying off your previous one. It involves having your current mortgage refinanced by another lender and combining it with a second mortgage to finance the new property. This can help you smooth out your monthly payments to maintain your debt level without increasing it. However, this option is expensive.

What precautions should borrowers take?

Before taking out a bridge loan, it’s important to consider several key points. First, the cost of the bridge loan is a key factor to consider. In fact, the interest rate on a bridge loan is often higher than that of a traditional mortgage. In addition, taking out a loan involves various fees: borrower’s insurance, application fees, and guarantee fees. It’s a good idea to run a simulation that includes all these factors to ensure your debt-to-income ratio remains manageable.

Next, the repayment period for the bridge loan is another factor to consider. The bridge loan must be repaid within a maximum of 24 months. If you have not been able to sell your property in time, the bank may convert the bridge loan into a standard loan if your debt-to-income ratio allows it. Otherwise, the bank may foreclose on the property financed by the loan or on the property awaiting sale.

The repayment terms of the bridge loan should also be carefully considered. As with a traditional mortgage, a bridge loan consists of principal and interest. You have several options to choose from: full deferral (you repay the principal and interest in a single lump sum upon the sale of your property) or partial deferral (you pay the interest and insurance monthly, and the principal is repaid at the end of the loan term). Full deferral may seem more advantageous, but it ends up being more expensive in the long run.

Finally, fluctuations in the real estate market are a factor to consider when taking out a bridge loan. As a bridge loan holder, you are at the mercy of market conditions. Fluctuations in the real estate market can make it difficult to sell your property. The bank has the right to demand repayment of the bridge loan on the scheduled date. You may therefore be forced to significantly lower the asking price in a rush to sell. In a slowing real estate market—as has been the case since 2022 with rising interest rates—taking out a bridge loan carries increased risk.