Bridging loans are a unique form of financing that can be used to purchase or refinance a property before the proceeds of a subsequent sale or refinance become available. In other words, it allows you to close on a property before you have the funds in hand to do so.
What is a Bridging Home Loan?
A bridging loan is essentially a short-term financing solution designed to bridge – pun intended – brief gaps in funding. Many people use a bridging loan when they want to buy a new home yet the buyer’s funds haven’t yet reached the seller’s bank account yet.
A bridging loan is often an interest-only home loan with a limited loan term, usually a maximum term of either six or 12 months. The expectation you will sell your existing home in this time – sounds reasonable right?
Bridging loans can be organised quickly, making them ideal for buyers who need to move quickly to secure the purchase of a new property.
Essentially, a bridging loan is a little bit like a line of credit that you take out to cover the ‘bridge’ between buying the new property and receiving settlement funds of the old property.
How does a bridging loan work?
When you take out a bridging loan, the size of the loan depends on how much debt remains on your old property, as well as the purchase price of the new property. These two values combined represent what’s known as your ‘peak debt’.
For example, if you still owe $350,000 on your older home loan and your new home is $900,000, your peak debt would be $1,250,000. Lenders typically allow home buyers to borrow up to 80% of this peak debt. Lenders also take into account the likely sale price of your old property and other costs of selling when assessing your borrowing power.
In crunching these numbers, bridging lenders may factor in a ‘fire sale’ buffer. For example this could mean they take 10-15% off your estimated property value to account for the possibility you’re forced to sell the property for less.
Bridging Loan Terms
Bridging loans are short-term loans which are normally offered for a period of six months but some lenders can offer a bridging period of up to 12 months. It’s extremely unlikely to find a bridging period offered for longer than 12 months because bridging loans are only a short-term finance solution.
If you fail to sell your old property within the set period, the lender may get involved with the sale and lower the sale price. This lower sale price might not be enough to pay off the entire bridging loan. In this instance, the remaining debt may be added to the new home loan.
What types of bridging loans are available?
There are two types of bridging loans: open bridging loans and closed bridging loans. Whether you need a closed bridging loan or an open one will depend on where you are in the process of selling your existing property, which we’ll explain more below.
Closed bridging loan
A closed bridging loan is used if you already have a contract of sale on your current property and your settlement date is fixed. A closed bridging loan can give you the temporary finance so you can buy your new property while you wait for the funds of the sale to come through.
Closed bridging loans are seen as being less risky and they’re generally easier to get than an open bridging loan because the sale of your old home has already been ‘locked in’.
You can capitalise the repayments into a single sum and pay it once you’ve received the funding from the sale of your old home.
Open bridging loan
An open bridging loan is used by buyers who have found their dream home and want to secure it even though they haven’t found a buyer for their current place of residence. As you can imagine, lenders are a bit more hesitant to offer an open bridging loan because the risk is greater.
Lenders will expect to see details about the new property and proof that you’re actually marketing your current home. Many lenders will also insist you have an exit strategy in place in case you can’t find a buyer for your current home. It’s likely you will also need a significant amount of equity in your current home to draw from.
Bridging loan lending criteria
There may be some requirements for bridging loans that don’t apply to other types of home loans, simply due to the nature of bridging loans. With many lenders, these are the criteria for bridging finance:
- Maximum loan to value ratio (LVR) meaning you need a minimum amount of equity to apply (usually 20%)
- Maximum loan term applies to bridging loans (usually between 6 and 12 months) in which time your current home must be sold by
- Not usually allowed to use a redraw facility on the bridging loan during the bridging loan term
- Not usually available for construction loans, company purchases or strata title purchases
The pros and cons of bridging loans
It’s important to weigh up the potential upsides and downsides before taking out a bridging loan. While they can bridge the gap between buying your new home and selling your old one, they aren’t the right solution for everyone.
Advantages of bridging loans
- Being able to move quickly to secure your new home even if you haven’t necessarily found a buyer for your old one yet
- Avoid the temporary inconvenience of having to pay two sets of principal and interest repayments on two separate home loans while you wait for your old property to sell
- You can avoid the hassle of having to rent a house between the time it takes to sell your house and purchase the new one
Disadvantages of bridging loans
- Bridging loans often have higher interest rates than standard home loans
- Capitalising your interest costs into the new loan means you end up paying interest on top of interest. That’s not to mention if you aren’t able to sell your existing property quickly, that interest will keep building up
- Pressure to sell before the end of the bridging period
- You may face break costs if your current home loan is a fixed rate one and you exit it early
- Bridging finance may require two valuations (on the current property as well as your new one) – that means two valuation fees which can cost a few hundred dollars each
Bridging loans can provide a quick and easy way to get the money you need to purchase a new property. However, they can be expensive and may not be the right option for everyone. If you are thinking about taking out a bridging loan, ask us for help. We can help you decide if a bridging loan is the right option for you and guide you through the application process.