A guide to bridging loans
A guide to bridging loans
28 Aug, 2020
Trying to sell your home while buying another can be tricky – especially when it comes to timing. Sometimes you‘ll find the ideal property before selling your existing home, leaving less funds available for your purchase.
Bridging loans can help homeowners “bridge” the gap between buying and selling properties. However, it can be complicated to get your head around and it is a decision that requires careful deliberation – aspects such as interest costs and certain terms and conditions for example, need to be considered before going ahead with the loan. To help with this, we have created a handy guide with all the things you need to know to gain a better understanding on bridging loans.
Related: The Benefits and Disadvantages of a Bridging Home Loan
What is a bridging loan?
A bridging loan is an additional loan you take out on top of your existing home loan, to help with the purchasing of another property whilst you’re trying to sell your old one.
This means during the selling period, you have two loans and are paying interest on both of them. These loans are particularly helpful in locations where properties can stay on the market for a while. Before buying, you should look into the clearance rates of your area to get a rough idea of how long selling might take.
After your current home has been sold, the original mortgage on the property is let go and the remaining bridging loan is then converted into your home loan for the new property. Typically, a bridging loan is an interest-only home loan with a limited loan term. The value of the loan is calculated according to the equity in your current property. Bridging loans also carry certain special conditions and loan structures that differ from lender to lender.
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Different types of bridging loans
Closed bridging loans
Closed bridging loans are used when a date of sale on your existing property has been determined. These loans are considered less risky by lenders as the property is already sold and they are aware of when they will receive payment. In this type of bridging loan, you will pay for the loan, any interest accrued and fees on the date of the sale.
Open bridging loans
Open bridging loans are used when you have found your next property but have not yet sold your old property. You should know that lenders aren’t a big fan of the uncertainty that comes with this arrangement. In this situation, you’ll need proof that your old place is being advertised and be ready to answer a lot of questions on your new property too. An open bridging loan can be made between six months up to 12 months. If this one-year limit is exceeded, you may face higher interest rates.
You might also like: What are the costs of Refinancing vs the Benefits
How does a Bridging Loan work?
To understand how a bridging loan works, let’s take into account an example scenario.
You have a house with an existing mortgage balance of $500,000 and plan to sell after seeing a new property. After being approved for a bridging loan, the existing $500,000 balance becomes the bridging loan with a maximum loan term of 12 months. For the new property, you get approved for a $600,000 home loan – this makes your debt total $1.1 million ($500,000 existing debt + $600,000 new debt).
There are now two scenarios in how your bridging loan can work.
- Your old property is sold
When your property is sold, you can use any remaining proceeds from the sale towards your new home loan to reduce the loan amount. For example if you sell the house for $700,000, you can use the $200,000 in proceeds to reduce your new home loan from $600,000 to $400,000.
Now that the property has been sold, the home loan switches from interest-only to principal and interest.
- The old property is sold for less than the mortgage balance of $500,000
If the old property fails to cover the entirety of the mortgage balance, the difference is added onto the new home loan, subject to approval by your lender.
Now that the bridging period is over, you begin making principal and interest repayments on the $650,000 home loan.
How can I be eligible for a bridging loan?
- You typically need more than 50% in equity to make a bridging loan worth it. Home equity is the difference between what your home is worth and the amount you owe on your mortgage.
- You’re expected to meet some standard requirements proving your current income, the status of your employment, expenses and other supporting documents.
- The bridging period must be between six and 12 months.
- Contracts must need to have already been exchanged on the sale of your existing property before you can get approved for a bridge loan.
How much can I borrow?
Under a bridging loan, you can borrow up to 80% of the peak debt. Peak debt is made up of your new property’s sale price plus your existing mortgage. This means you need to have at least 20% of the peak debt in your savings to act as a deposit for your new place.Advantages of a bridging loan
You can wait to get a better price on your old property
With a bridging loan, you have time to get a better price on the sale of your old property, so you can avoid the stress of having to sell quickly. You may also be able to get a better price and use it towards paying off your loan.
No difference in fees and charges
In the past, application fees for bridging loans were typically higher. Nowadays, only standard fees apply and they are usually no more than $600
Unlimited principal and interest payments
Banks have in the past charged a higher interest rate for bridging loans, but now there are no penalties attached to making extra payments on the loan. You can pay as much off as you like, however often as you’d like.
Frozen loan repayments
Your bridging loan repayments are usually frozen until you sell your old home. This means you will only need to keep up with one set of repayments rather than two.
Disadvantages of a bridging loan
Compounding interest
Because you’re taking on a new loan on top of your existing one, the longer it takes to sell your property, the more interest your bridging loan and old loan will accrue. This means that the interest could add up quite quickly and you will end up paying more for the loans in the long run.
No redraw facility
As a featureless loan, a bridging finance loan will not allow you to a redraw facility. Consequently, you won’t be able to withdraw any extra repayments made.
Early termination fees
Your current lender might not have a bridging loan available, which means you’ll have to find another lender who will. If you decide to refinance using another lender, then you may attract an early termination fee and break costs, especially if it’s during a fixed interest period.
Two valuations instead of one
Having two properties (your current one and the one you’re looking to buy) means the bank will need two valuations. Valuations are quite costly, at $200-300.
Does a bridging loan affect your credit score?
Taking out a bridging loan doesn’t directly affect your credit score, but your repayment schedules will. If you repay your bridging loan on time, this will improve your credit score.
However, if you consistently miss repayments, this can be reflected poorly on your overall credit score. For a more in-depth explanation on credit scores and how they work, check out our guide here
Traditionally, a credit score is used to judge a borrower’s reliability. With a bridging loan though, the lender is looking more at the property put up by the borrower. Lenders are already protected because defaulting on repayments would give them the right to sell the security under the terms. As the lender, this gives them added protection, so less weight is given to the individual’s credit history.
Related: What is a credit score and how is it calculated?
Is it possible to get 100% bridging finance?
Under a bridging loan, you can only borrow up to 80% of the peak debt. Your peak debt is calculated using the sum of your new property’s sale price plus your existing mortgage. This means you need to have at least 20% of the peak debt in your savings to act as a deposit for your new property.
Do you want to find out more about bridging finance? Then contact eChoice, our brokers have access to 100’s of products, so we’ll find you a competitive mortgage rate.
Words by Joanne Ly
Contact the brokers at eChoice today if you’re thinking of selling your home. Our brokers have access to 100s of products that will help you secure a competitive deal when applying for a home loan.