In an ideal world, we’d all be able to perfectly synchronise the dates that we sell our old home and purchase a new one. But we don’t live in a perfect world - selling via private treaty can be unpredictable, and the auction marketing process is typically done and dusted in four weeks.
Sometimes, you find your dream home and you want to secure it before someone else swoops in – but you don’t have the funds to purchase it because the dust (money) hasn't settled on your old home.
Enter the bridging loan.
Bridging finance, or a bridging loan, works as a short term loan that finances the purchase of a new property while you’re waiting to sell your existing property.
What is a bridging 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 before receiving the funds for the sale of their previous home.
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.
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. One bridging finance lender, TechLend now called Bridgit, says it can approve finance in a day.
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.
When you end up selling your existing home, the amount left is known as your ‘end debt.’ For example, if you have a ‘peak debt’ of $1,250,000 and you sell your existing property for $650,000, your ‘end debt’ would be $600,000.
When you eventually manage to sell the old property, the proceeds of the sale are used to pay off the existing debt, after which the bridging loan is closed and the remaining debt (mostly for the purchase price of the new property) becomes a standard home loan.
You may then start making principal and interest repayments off the new loan and any leftover funds from the sale of the old property could be used as a lump sum principal repayment off it.
Be sure to contact your lender to confirm what loan conditions apply after the bridging loan period ends.
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.
Keep in mind you’ll be required to pay your original home loan (existing property) and the bridging finance simultaneously. You’ll likely need to show evidence that you are capable of repaying the bridging finance interest costs during the buying and selling period.
How long can you have a bridging loan for?
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.
What is the average interest rate for a bridging loan?
Bridging loan interest rates tend to be higher than normal owner occupier loans. For example, if a regular home loan is around 6.00% p.a., it won’t be unusual to see a bridging loan around the 8-9% p.a. mark.
This is because the terms are shorter, and the lender's risk is generally higher. No that doesn't mean you're a deadbeat. However, stuff happens. Maybe the buyer's finance for your old home falls over and some hiccups happen. Maybe your new home is re-valued at fewer monies.
And because the interest rate is expressed as p.a. - per annum or year - when condensed down to three or six months, the interest paid in reality is half or a quarter of that.
How do bridging loan repayments work?
During the bridging period, the borrower typically accrues interest costs on the two sets of debts - the existing home loan on the old property, plus the new home loan for the new property and other costs.
Affording principal and interest repayments on what’s likely to be a much larger debt than you’re used to can be very hard for the average Aussie – even if it’s just for a short while. Thankfully, many bridging loans only require interest-only repayments, which can be much easier to meet.
Some lenders also offer the option of delaying these repayments during the bridging period by capitalising the interest repayments on top of the loan balance, although this essentially means you’ll be charged interest on your interest costs.
Lenders also tend to allow borrowers to make voluntary principal payments during the bridging period, which could help reduce the total interest paid.
Bridging finance for construction
Most bridging loans are only for the purchase of existing property, though some lenders may offer bridging loans for the construction of a new property. If you would rather stay in your current home while you build your new home, a bridging loan can be a good option as it saves you from the hassle of selling your home and renting elsewhere in the meantime. Plus, you have the added bonus of only having to move your stuff once!
There are also bridging loans specifically for seniors who are either moving into another home/assisted living facility while their current home is on the market or are waiting for retirement benefits to start flowing.
What are the requirements for a bridging loan?
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.
Pros of bridging loans
- Convenience: Being able to move quickly to secure your new home even if you haven’t necessarily found a buyer for your old one yet
- Repayments: 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
- Avoid renting: 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
Cons of bridging loans
- Interest rates: Bridging loans often have higher interest rates than standard home loans
- Paying interest on interest: 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: If you don’t sell in the agreed period, you could be left with a large interest bill, or the bank may take matters into their own hand e.g. selling it for you
- Fees: There are often additional fees and charges involved with bridging finance
- Bridging finance may require two valuations: On the current property as well as your new one. This means you may have to pay two valuation fees which can cost a few hundred dollars each.
Alternatives to a bridging loan
While a bridging loan may seem like an attractive option, it’s not the only option to consider. Instead, you could choose to:
- Negotiate a longer settlement period on the sale of your new home. This could give you some extra time to sell your existing home before the loan for the new home commences.
- Put a ‘subject to sale’ clause in the purchasing contract of the new home (this may or may not be possible depending on the vendor’s decision).
- Stay with family and place your goods in storage - avoid the cost of renting while finding your next home.
Be sure to consider all your personal and financial circumstances before deciding on the right option for you.
Savings.com.au’s two cents
The thought of taking out bridging finance and effectively owning two properties at once is enough to send a chill down many homebuyers’ spines. If you’re risk-averse, bridging finance probably isn’t for you. Then again, if you’re risk-averse you probably wouldn’t buy before selling anyway.
Bridging loans aren’t for everyone and for many it's still better to sell their current home before buying a new one.
However, the property market can be riddled with uncertainties, and it’s not always possible to perfectly match up the dates that you sell your old home and buy the new one. Sometimes you find your dream home and want to pounce on it before anyone else can get their grubby mitts on it – even though your current home remains very much unsold.
In this case, a bridging loan can give you the ability to move quickly by giving you a temporary finance solution – but it pays to be aware of the risks. The biggest one is that your home doesn’t sell within the bridging period. If that happens, some lenders may jack up the interest rate or force you to sell the property for a much lower price. Most will just revert the loan back to a principal and interest loan and require you to pay them both off at the same time. Depending on your circumstances, this could place you in severe financial difficulty.
Before taking out a bridging loan, be realistic about the price your property will sell for and how long it will take to sell. Think about what you’ll do if your home doesn’t sell as quickly as you think it will.
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