Trying to sell your home and buy another can be tricky – especially when it comes timing. Sometimes you’ll find the ideal property before selling your existing home, leaving less funds available for your purchase. But the good news is that a bridging loan is sometimes available to cover the shortfall.
Bridging loans can be complicated to get your head around and it is a decision that requires careful deliberation. We have created an entry-level guide answering popular questions to help you gain a better understanding on the matter.
How does a bridging loan work?
A bridging loan is designed to ‘bridge’ the gap when you’re trying to secure a new mortgage for a new property but haven’t yet sold your existing property. This loan allows you to buy your new place without waiting for the old one to sell. They 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. This also means that while you wait for your first property to sell you are accruing interest on both loans.
Different types of bridging loans
Bridging loans usually take two forms: open bridging loans or 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 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.
A bridging loan can be quite risky and isn’t the best option for many people. You may be better off asking for an extended settlement period or just waiting for the sale of your old property.
How long can you have a bridging loan for?
In an open bridging loan – the usual form – you will have between six and 12 months to sell your existing property. If you have a closed bridging loan, your loan will last until your date of sale. This is called the ‘bridging period’ and your repayment terms will depend on your lender. During the bridging period, you may be asked to make repayments on the loan. However, some lenders will freeze your bridging loan repayments and only ask for repayments on your existing loan.
Do I qualify 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. Want more information on equity? Check out our guide.
- 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.
How much can you borrow on a bridging loan?
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.
How is a bridging loan calculated?
How much your bridging loan costs is a simple calculation made by the banks. The banks take the price of your new home, add the remainder of your mortgage and then subtract the most likely sale price of your current home. This valuation from the bank will cost you a couple of hundred bucks per property. They will also reduce your projected sale by about 15% as a “fire sale buffer” in case your property falls short of the expected price.
This final number is called an “ongoing balance” or “end debt”. Much like a normal loan, the banks will then assess your ability and reliability in paying off this loan.
The total amount borrowed is called the “peak debt” which includes the ongoing balance of your existing mortgage, plus your new mortgage and all associated fees including stamp duty, legal fees and lender fees.
Does a bridging loan affect your credit score?
It can – if you repay your bridging loan on time, this will improve your credit score. But, if you make late repayments this will be detrimental to your credit score. We recently put together a guide on credit scores which will give you an in-depth explanation.
Can I get a bridging loan with bad credit?
Traditionally, those looking for a loan are expected to provide their credit score to judge their reliability to lenders.
With a bridging loan though, the lender is mainly worried about the security put up by the borrower – this part is non-negotiable. With a bridging loan, the lender is protected because defaulting on repayments would give them the right to sell the security under the terms. As the lender has this added protection, less weight is given to the individual’s credit history.
Can I use a bridging loan to buy a house?
Yes – bridging loans are designed to finance your new purchase before your old property is sold and settled.
Do banks still offer bridge loans?
Yes, they do, and some lenders have now lowered interest rates to standard rates. Previously, the rate for a bridging loan was higher.
Can you get 100% bridging finance?
No, you cannot. Under a bridging loan you can borrow up to 80% of the peak debt. Your peak debt is 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.
Words by Michelle Elias