What is a bridging loan?
If you’re looking to move houses, then you’ve probably heard of the term “bridging finance”. We break down what a bridging loan is, and how a bridging loan works.
A bridging loan is when you require finance to purchase a second property with the intention of selling the existing one. A bridging loan is typically an interest only payment home loan with a limited loan term. The extent of the bridging loan is calculated on the equity in your current property.
It is an additional home loan that you take out on top of your current home loan until the property is sold and the loan can be closed. This means during the bridging period you have two loans and both loans are being charged interest.
Some loan structures only require you to make repayments on your original loan until settlement. During the bridging period, the interest on the bridging loan gets added to your ongoing balance on your bridging loan. However you don’t have to make repayments on it until your existing property is sold. Other loan structures require you make payments on both loans from the time you open the new loan.
When your current home is sold, the bridging loan is converted into your chosen home loan for your new property.
Normally, the interest is compounded monthly, which means the longer it takes to sell your property, the more interest that will accrue. You will also need to check the bridging period, which is usually six months for purchasing an existing property. Lenders can charge a higher interest rate if you don’t sell your property within this time frame.
Why you would get a bridging loan
By taking out a bridging loan, you can avoid the stress of trying to match up settlement dates. This may give you a better chance of selling your existing home at a reasonable price without time pressure.
Borrowers can usually also add the upfront costs of buying a home to a bridging loan, such as stamp duty, legal fees, and inspection fees.
However, please note that bridging finance may not be available or suitable for every borrower. Lenders often require that you have a certain amount of equity in your existing home so you can provide a substantial deposit on your new home to have a lower LVR. Or lenders may require that borrowers without equity in their existing home pay a higher interest rate on their new home’s bridging loan.
How does a bridging loan work?
When you take out a bridging loan, the lender usually finances the purchase of the new property, as well as taking over the mortgage on your existing property.
The total amount of finance borrowed is known as the ‘Peak Debt’. This is generally calculated by adding the value of your new home to the outstanding mortgage from your existing home. By then subtracting the likely sale price of your existing home, you’ll be left with the ‘end loan’ and this will be the overall balance of the new loan.
During the bridging period, interest will be compounded monthly on your ongoing balance at the standard variable rate.
Below is an example of a scenario:
Luke has found his dream house and is looking to take out a bridging loan.
The current mortgage on his existing property is $400,000 and the estimated value of the current property is $800,000. He intends to purchase the new house for $1,000,000 plus cost of $50,000.
Peak Debt = $400,000 (current loan) + $1,050,000 (New property Loan) = $1,450,000
Given Luke is estimating to sell his house for 800,000 end loan is as follows assuming selling cost of $25.000:
End Loan = $1,450,000 – $775,000 = $675,000
Requirements for a bridging loan
There are a few requirements that may apply to bridging loans that wouldn’t apply to other types of home loans. With many lenders, criteria apply such as:
- Maximum LVR requirements can apply, meaning you need a deposit of a certain amount in order to apply, e.g. a 25% deposit.
- Maximum loan term can apply to bridging loan, e.g. your current home needs to be sold in 6 months.
The pros and cons of bridging loans
It’s important to look at the pros and cons of bridging loans, because like any financial option, it’s important to do your research and compare your options before diving in. Finance Circle Group can assist with the legwork.
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The information on this website is general information only and is not intended to be a recommendation. We strongly recommend you seek advice from your financial adviser as to whether this information is appropriate to your needs, financial situation and investment objectives.