If you’ve discovered your ideal home on the market, but have yet to sell your current one, don’t despair. A bridging loan can help.
What is bridging finance?
If you’re looking to buy or build a new home, but haven’t sold your current one yet, a property bridging loan is a popular solution. Essentially, it is a short-term home loan that provides the funds you need to purchase or build a new property.
Once you sell your current property, the proceeds are used to pay off the bulk of the bridging loan, and the remaining amount reverts to a normal mortgage.
Bridging loans are available from both from banks and non-bank lenders (financial companies).
How short is short-term?
Most lenders offer 6 month bridging loans if you’re selling or 12 months if you’re building a new home.
How does it work?
Bridging finance is calculated by adding your current mortgage debt and the cost of your next property together. The result is called your Peak Debt (the total amount to be borrowed).
The formula might look something like this:
Remaining Debt + Cost of New Property = Peak Debt
Just like any other loan, bridging loans accrue interest. This is calculated monthly and you can either choose to pay it off each month or have it added to your Peak Debt. This is known as capitalised interest. It’s important to note that not all lenders offer the capitalised interest option.
Bridging finance explained. Let’s look at an example.
Miss Smith has her eye on a property worth $700,000, but she hasn’t sold her current property yet. A valuation has found her current home is worth $550,000 and she has $200,000 remaining on her mortgage. If she took out a bridging loan, here’s what it would look like:
$200,000 + $700,000 = $900,000 Peak Debt.
With the purchase of her new home, Miss Smith now has a short-term debt of $900,000. For the sake of simplicity, let’s say she pays off the interest on this loan each month while her old home is on the market.
When Miss Smith’s old home sells for $550,000, the net proceeds of that sale pay off the bulk of her loan, leaving her with $350,000 of End Debt remaining. This End Debt is then converted into a normal mortgage.
$900,000 (Peak Debt) – $550,000 (proceeds from selling her old home) = $350,000 (End Debt).
The pros of bridging finance
You can buy or build a new property without having to wait for your current one to sell.
Your loan repayments only require you to pay off the interest of your loan, not the principal amount.
If your current home sells for more than the value of the bridging loan, you can use the money to pay it off quicker.
Cons of bridging finance
There’s no denying that bridging loans are useful. However, they do come with a few inherent risks that buyers and sellers need to know.
The interest rates are generally higher.
If you haven’t paid off your current home, you may have to pay two loans at once—your current mortgage and the interest accrued on the bridging loan.
Financial strain if your home doesn’t sell, takes longer to sell than planned, or sells for less than you expected.
Not everyone can qualify for a bridging loan. Buyers have to meet each lender’s specific criteria.
Setting up a bridging loan comes with quite a few fees. There have been reports of homeowners needing to pay additional legal and valuation fees to secure the finance. Ask your lender to quantify these up front so you can plan accordingly.
Always consult a professional
Always get advice from a mortgage broker or your bank before you take out a bridging loan. This type of finance has a number of caveats and professional guidance is essential to using them effectively.
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