What is a bridging loan?
A bridging loan is a type of home loan that enables existing homeowners to use their property to buy a new home—without having to sell their existing home first. A key feature of a bridging loan is that the lender makes it a condition that the existing home be sold within a specific timeframe, usually around six months.
Who can use a bridging loan
Bridging loans can suit homeowners with significant equity in an existing property.
Bridging loans can suit homeowners who do not wish sell prior to finding their next home. This way they can avoid the inconvenience of potentially having to move twice – once to a rental and twice to their new home.
Bridging loans can suit homeowners who are comfortable taking on more debt over the short term.
Bridging loans can suit homeowners who do not wish to buy a property “subject to the sale of their existing home”—which could possibly deter sellers.
Every five year period sees over 40% of Australians moving house. While not all of these people will be homeowners, any borrower moving addresses might benefit from understanding how a bridging loan might help them.
How does a bridging loan work?
Lenders that offer a bridging loan solution need the homeowner to allow both properties with with the same lender. This is because their combined value is used to support the bridging loan. As not all lenders offer a bridging loan, you may need to refinance to a suitable lender to access a bridging loan.
If ever an example was needed, it is to illustrate this—how a bridging loan works.
A bridging loan, also referred to as bridging finance, is loan structure to get you from one place into another, without having to sell first.
Let’s say you want to buy a new home before you sell your existing home.
You might wish to improve your chances your offer to purchase being accepted without onerous conditions—like, “I want to buy your place, but can you at least wait until I sell mine?”.
An example of how a bridging loan works is here.
Say you live in a home worth $500,000 and have built up some property equity over the years. You currently owe $200,000 and you would like to move house.
You find a property to buy for $700,000. Let’s allow for additional costs of $35,000 for things like stamp duty. So, you need $735,000 in total.
You want to purchase the new home now—but have not sold your existing property yet.
A bridging loan may help here.
We need $735,000 for the new place but wait—you also need $200,000 to cover your existing home loan. That is $935,000 in total.
In addition to the usual home loan assessment process, most bridging loans need to meet two pass two key hurdles.
The first relates to the overall loan to value ratio being within the lenders guidelines while the loan is at its peak—while the bridging loan is in place. This example shows an LVR of 78% based on an overall loan amount of $935,000 and combined property values of $1,200,000.
The second hurdle is for the borrower to satisfy the lender that they can afford the loan that will remain after the bridging loan is paid off.
A bridging finance structure normally has two separate loans that make up the total of $935,000. A bridging loan (short-term) and a standard home loan (longer loan term).
The bridging loan of $450,000 is the temporary loan amount you agree to pay off immediately upon selling your existing home. The amount of bridging finance allowed is usually capped, depending on the lender as it must be paid off when your property sells—so it needs to allow for price movement and selling costs.
The remaining amount of $485,000 will be the regular home loan set to remain after the sale of your existing home has gone through and the bridging loan has been paid out.
Bridging loan repayments
A bridging loan is over a shorter-term (generally less than 12mths) that sees borrowers temporarily takes on more debt than if it were a traditional home loan. So, the monthly repayment options are also designed to be temporary.
These repayment options can be more costly when compared to a normal home loan. This is because a bridging loan is problem-solving in nature—a higher risk product for the lender compared to a home loan designed to be affordable over the long-term.
Here are two common repayment options for a bridging loan. These are designed to place less strain on borrower finances compared to classic principal and interest home loan repayments. Each option depends on lender policies as well the property equity a homeowner can demonstrate.
Interest only repayments
Interest only repayments require the borrower to meet the costs of the loan—being interest and fees. The amount of the loan will not reduce during the interest period because the repayment is interest only and not principal and interest.
Borrowers need to have funds available to make these payments. Lenders will usually entertain two types of monthly repayment strategy—repay from spare monthly cashflow or savings that have been set aside for bridging loan repayments.
Capitalised interest
Capitalised interest is when home loan charges (like interest and fees) are added to the loan amount, instead of the usual deduction from a transaction account. This result being an increase to the loan amount owed.
So, if a borrower owes $450,000 at an interest rate of 5%, the first month could see a $1,875 interest charge. Capitalised interest would see the home loan increase by the same amount to $451,875. This means the interest charge for the next month will be on the higher loan amount of $451,875.
An attractive feature of capitalised interest is that the borrower does not need to find the funds to pay the interest each month.
What borrowers should also understand is that lenders charge interest on any loan amount owed. So, if the loan amount is increasing each month, then so too will the interest charge.
Capitalising interest to meet repayment obligations could be considered risky and expensive. That might be true for a long-term loan arrangement. Given bridging loans are short-term, the defined time-period means the amount of capitalised interest can be contained.
Are bridging loans expensive?
Whether you think a bridging loan is an expensive option, depends on what you compare it to. Here are some pros and cons to consider for a bridging loan:
Pros
- More control for the homeowner in buying first before committing to a sale.
- Move once so avoid the costs and inconvenience of moving twice.
- No rent payments given you move straight into you next purchase.
Cons
- Interest rates and fees can be higher than a standard home loan.
- Homeowners need significant property equity.
- Bridging loans can prove expensive as they are designed to be temporary. Borrowers need to be realistic about the selling price and selling timeframe of their existing home. The longer it takes to sell the existing property, the more interest you pay on the bridging loan. Much of this can be forecast and prepared for with proper planning.
There are some things you cannot put a number next to which makes any comparison difficult. Ultimately the comparison is for you to make. A mortgage broker can help weigh up the pros and cons of a bridging loan and whether it suits your individual circumstances.
Final word
Just like any home loan, a bridging loan needs to pass a lending assessment. The bridging loan component is more a question of there being enough equity – as well as choosing a lender with the appetite for it.
Bridging loans do not have market-leading home loan rates, but given the short-term nature of bridging finance, many costs can be planned for in consultation with your lender or mortgage broker.
