A bridging loan or 'bridging finance' is a short-term loan used for up to 1 year. Bridging loans are used to 'bridge' the gap between selling your existing home (existing home loan) and buying a new home (new home loan).
Bridging loans work like a second home loan that you take out whilst you are in the process of buying, and selling, and moving to your residential property.
The bridging loan period varies depending on when your property sells which also affects the loan costs. You must be confident that you will sell your existing home before the maximum loan term is reached.
Open and closed bridging loans
Open bridging loans are when you do not have a set period or exit payment strategy for the end of the bridging loan term. Your current lender may be waiting for the sale of your existing property, but you do not know when that will occur or how much you will receive.
Closed bridging loans have a predetermined exit payment strategy. For example, you might already have a settlement date for the sale of your existing property but is after the settlement date for your own buying a new property.
Most banks and credit unions offer bridging loans. If you seek to obtain a bridging loan with your existing lender, you may be able to use the equity in your existing home loan.
When will I need a bridging loan?
Buying a new home can be one of the biggest decisions of your life. When the perfect house hits the real estate market, you do not want to miss out. You must act quick to secure your dream home and you might not have time to sell your existing house, or it is already on the market, and you are waiting for the right offer.
This is when you might need a bridging loan depending on the market conditions and your personal circumstances.
If you’ve already paid off the loan on your existing home, then great! That just means applying for a new home loan for the new property. When your existing property sells you can transfer the funds you get from the sale and current mortgage onto your new home loan. Speak to your lending specialist about your plans so arrangements can be assessed and made.
How does bridging finance work?
Buying new property before selling current property
Let’s say you still have $200,000 to pay off on your existing home which is worth $500,000.
You are eyeing off a new home and expect the purchase price to be $600,000 but you haven’t got enough equity in your current house yet, and you don’t have the cash to cover loan repayments on both loans.
A bridging loan will cover you for the cost of your new property plus the cost of your new home:
$200,000 + $600,000 = $800,000
You then sell your current home for $500,000. That’s taken away from available equity for the bridging loan amount:
$800,000 – $500,000 = $300,000
Your loan on your new home is now $300,000.
Keep in mind that this is a very simplified overview of how a bridging loan works. Bridging loans are a short-term option. As such, they usually attract higher interest rates, and often come with the usual application and exit fees associated with a regular home loan.
You also must consider purchase costs such as stamp duty and real estate fees when you purchase and sell property.
The upside is that many lenders understand the temporary nature of a bridging loan and won’t ask you to make principal and interest repayments during the bridging term. However, you will still need to make the monthly interest payments on the new loan amount, which because of the higher debt level maybe substantially higher than your current mortgage repayments.
Selling existing property before buying
If you sell your existing house before finding a new home, you have a few different options.
Selling before buying offers great financial advantages, but there are also a few gaps you should keep in mind as well.
On the upside, you get plenty of time to shop for a new house, buy it, and move into it at your leisure. You’ll have sorted out your finances and paid off any remaining debt on your old house when you sold it – and possibly made a nice profit on the sale!
On the downside, you still need somewhere to live between selling and buying. Some people can move in with friends and family. For extremely short-term stays, some stay in motels (but this gets very expensive, very quickly).
The most popular option is renting. It’s cheaper than a motel, of course, and doesn’t put strain on relationships if you were to live with friends or family. The downside is that you still must find a rental property, and sign a lease, which you may need to break if you find your dream home to buy. Breaking a lease is still often easier and cheaper than the alternatives and gives you a solid base to house-hunt from.
You should also consider that you’ll have two lots of moving to do and two rounds of setting up utilities as well. But, it can be worth it not to have to juggle two houses at once.
Advantages of bridging loans
- Bridging loans can be very convenient because you can buy your new dream home when it becomes available and not miss out.
- Convenience of not having to rent or move in with family and avoid the costs and hassle of moving twice.
Disadvantages of bridging loans
- Taking out a bridging loan increases your peak debt, and you will need to cover the interest on the increased loan until your property is sold.
- You don't know how long it will take to sell your home and if you get a lower price than you expected for your original property. It can be risky because you have already committed to your new home.
- A bridging loan is for a set term and if you do not sell your house within that term, you may find yourself in default on the loan.
What happens if I can't sell my house before the bridging period ends?
A bridging loan is generally a 12 month facility so if it is not paid out within that timeframe it is technically in default and the bank can sell the property.
Usually the bank will renegotiate the loan, but may have conditions that the property price is reduced in order to sell the old property. In some extreme circumstances the bank may leave it in default and start the process of selling the property.
Because bridging loans have a large degree of risk from the perspective of the lender, lenders will carefully consider the circumstances of a bridging loan application before approving due to the high level of risk.
Alternatives to bridging loans
There are a few different options available if you buy your new property before selling the old property.
- Extending the agreed settlement date on the new property can give you enough time to sell your current property and prevent the need for a bridging loan. A longer settlement period might not suit the seller.
- Renting from the buyer of the new property can be an option if they are willing.
- Renting your existing property from the new purchaser is another option if they are willing.
Relying on these alternatives can be risky.
Is a bridging loan right for me?
A bridging loan could work for you, but it depends on your personal circumstances and your financial goals. Speak with a Lending Specialist or a financial advisor to help determine what best suits you.
This article is general in nature and does not constitute personal advice. Consider your circumstances and read terms and conditions before making a decision on whether a product suits your needs.
For all loan enquiries chat with a member of our lending team by arranging an appointment on 02 6763 5111.