A bridging loan is a short-term loan to help you manage your cash flow between two transactions, such as the buying of one house and the selling of another.
When you take out a bridging loan, the lender will take over the mortgage on your existing home in addition to financing the purchase price of the new property. You can borrow up to 80% of the peak debt with a bridging loan. Peak debt refers to the sum of your outstanding mortgage and the sale price of your new property. Therefore, you need to have at least 20% of the peak debt in savings or as equity in your home to qualify for a bridging loan.
How does a bridging loan work?
During the term of the bridging loan, you are only required to make the principal and interest payments on your existing loan. The interest on the bridging loan used to finance the new property is generally capitalised on the peak debt so that you don’t have to pay anything extra until your house is sold.
Once you sell the property, the sale proceeds are used to reduce the peak debt. The outstanding amount, also known as the end debt, becomes your new loan. The end debt is typically paid off as a standard principal and interest loan.
What are the benefits of bridging finance?
Perhaps the most significant benefit of bridging finance is that it helps you buy a new house before selling an existing one. There are many reasons why you may want to sell your current home and move to a new property. Perhaps you want to move closer to work or upsize your home to make space for a new family member. However, it can be challenging to secure a contract to sell your existing home and simultaneously close on a new one.
Even if you do find the right house to move to, you may not be able to make a down payment on the second home without receiving the sale proceeds of your first home. A bridging loan can help you overcome this situation by ‘bridging’ the gap between the sale and purchase of two properties. Additionally, a bridging loan also helps you:
- Procure a better rate on your existing property by giving you more time to market the property and negotiate with potential buyers.
- Avoid the hassle and expense of living on rent after selling your existing property and then shifting again once you find your new home.
- Maintain your cash flow by making payments only on your current loan until your house is sold. You could even opt to pay interest on your bridging loan in addition to your original mortgage repayments to reduce your end debt.
What you should know before applying for bridging finance
Even though a bridging loan is a convenient way to finance your new home when you still haven’t sold your existing home, there are a few pitfalls you need to know about.
- The interest rate on a bridging loan is generally higher than what you’ll pay on a standard home loan. Additionally, the longer it takes to sell your home, the more interest your new loan will accrue.
- Your end debt is calculated by subtracting the sale price of your existing home from your peak debt. However, if your current home sells for a lower amount than what you had anticipated, the size of your new loan (or your end debt) will be more than what you had budgeted for. This will result in larger monthly repayments, which may be difficult to manage depending on your circumstances.
- Not all lenders offer a bridging facility. If your current lender doesn’t provide a bridging loan, you’ll need to refinance your existing loan with another lender who’s ready to advance you a bridging loan for your new home.
Despite the potential drawbacks, a bridging loan could help you get better value for your existing home while allowing you to purchase a new home as soon as you find one. However, you’ll need significant equity in your current home to be eligible for a bridging home. If you’d like to find out more about bridging loans and whether you’ll qualify for one, speaking to a mortgage broker could help.
