Bridging Loans: How does Bridging Finance work?

Moving houses is tough, especially when you haven't sold your current residence yet. The financial burden of purchasing another property while paying for your existing home can be daunting. The good news is you can apply for a bridging loan to help you buy a new home while your house is still on the market.

Learn the basics of a bridging loan and how it can help you.

What is a bridging loan?

A bridging loan includes a short-term bridging period that helps buyers cover the purchase price of a second property, without the need to sell your current property first. This type of loan is made to cover the short gap between selling your previous home and buying your new property. With this loan, buyers will have enough funds to cover their current mortgage and buy a new home at the same time.

As the name implies, a bridging loan is there as a bridge to help you transition from your old house to your new one. Usually, the bridging period of a bridging loan has a term of six to 12 months. This means you have to follow a strict deadline when selling your home.

How does a bridging loan work?

The lender of the bridging loan typically takes over the debt on your current mortgage while also providing financing for your new property. The size of your bridging loan will depend on the following:

• The purchase price of your new property

• The remaining balance you have on your current home loan

These two factors make up your 'peak debt' or the total amount borrowed from that lender. Your peak debt may also include other costs such as legal fees, stamp duty, and other fees lenders may decide to impose on your loan.

Once the previous property is sold, the net proceeds of the sale will be used to pay off some of the peak debt. After, you'll be left with the 'end debt' and your bridging loan will function as a typical mortgage. If your old property isn't sold within the bridging loan term, the lender may apply special conditions such as increasing the interest rate.

Bridging loan interest rates

Generally, bridging loans have higher interest rates compared to the traditional home loan. Because of the nature of bridging loans, lenders may compensate for the higher risk of borrowers defaulting by applying a larger-than-usual interest rate.

The interest you pay throughout the loan term depends on the lender. Usually, borrowers accrue interest on their existing mortgage and the bridging loan. With some lenders, the interest rate on the unpaid debt from the previous home loan may be capitalised and added to the peak debt. Meanwhile, other bridging home loans make the borrowers pay two repayments (for the active home loan and the bridging loan) as soon as they take out the short-term property finance.

Bridging loan terms and repayments

Bridging loans are often interest-only so you only pay interest on the loan for a set period. This lets borrowers more easily juggle payments for the new loan and their current mortgage.

At loans.com.au, we don't charge interest on our bridging loan for the first three months of the bridging period. For months four through to six, the interest accrued will be capitalised and added to the peak loan debt. From months seven to twelve of the bridging finance period, monthly interest-only repayments will be charged.

The bridging period for bridging finance usually come in six to 12-month periods. It's unusual to find bridging loans longer than 12 months because these are designed to be short-term property finance solutions.

Pros and cons of a bridging loan

Before you decide to take on a bridging loan, make sure you're aware of the advantages and drawbacks. Keep the following in mind:

Pros of a bridging loan

• You can buy the home you want immediately. No need to wait until the sale of your current home to start moving properties.

• You can avoid renting a property in the interim. Renting requires a lot of time and effort, not to mention the additional costs. By taking out a short-term bridging loan, you don't have to move around multiple times.

• You can streamline loan payments. Some lenders will let you make repayments on your current loan and then start bridging loan repayments after you've sold your old home. This means you're not juggling multiple loan payments at once.

• You can incorporate additional costs into the bridging loan. This will make paying for your new home much more convenient. You can include stamp duty, legal fees, and other costs of your property purchase in the bridging loan provided you have the borrowing capacity available.

Cons of a bridging loan

• You may have to sell your property at a lower price. Because of the strict timeline with bridging loans, you may have to leave a lot of money on the table just to sell the property quickly before the bridging loan term ends.

• You will have to have two property valuations. One for your current property and another for the property you intend to purchase. Additional valuation fees could quickly add up and leave you with more expenses.

• You may have to pay higher interest rates. During the bridging finance period, you'll likely be charged a higher interest rate compared to a standard home loan. And if you don't sell your home within the loan term, you could end up paying even larger interest rates.

• You may have to pay termination fees. If you're switching lenders to get a bridging loan, you'll need to pay early exit fees on your current mortgage.

Difference between open and closed bridging loans

There are two types of bridging loans you can choose from. Although both offer short-term property finance, the conditions for these loans are different. Some lenders also only offer one type of bridging loan.

Open bridging loans

An open bridging loan is used when you haven't sold your current property yet. You can take out an open bridging loan if you've found a property you want to buy but still have your old home on the market. This is a more open-ended loan.

Closed bridging loans

A closed bridging loan is for those who have a Contract of Sale on their old home. This is for those who are in the process of transferring the property and know when it will be sold. For this type of bridging loan, borrowers will pay the loan and the accrued interest fees on the date their old home is sold.

How do you qualify for a bridging loan?

Bridging loan eligibility varies from lender to lender. Lenders will typically look at the following before approving your bridging loan application:

• Home equity - the more equity you have in your old home, the less you must borrow from the lender. Some lenders require a minimum equity of 20% to apply for a bridging loan.

• End debt - lenders are going to look at how much end debt you're likely to have. There are lenders out there who provide bridging loans as long as there's an end debt which may not be the case when downsizing.

• Sale contract - if you opt for a closed bridging loan, lenders may ask for proof of sale or a copy of the sale contract for your existing property.

Want a low rate bridging loan? Get in touch with loans.com.au

Learn more about bridging loans and how they can assist with your move! Contact one of our friendly lending specialists today and let them help you achieve your real estate goals.

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