What is a bridging loan?
7 min read
A bridging loan (also known as bridging finance) is a short-term loan which helps you to finance your next purchase while you wait for your current property to sell.
What is a bridging loan for?
Lots of people sell their current home and use the equity to fund into their next purchase, however sometimes it’s not possible to line up the sale dates and your purchase might go through before your sale. This is where a bridging finance comes in. People also use bridging loans if they are living in their current property whilst they are building their new home.
The way the loan works, is the bank extends a line of credit to you to cover your contribution to the next property. Then when your current property sells, those funds will be used to pay off your existing home loan and the bridge loan, leaving you with just the one home loan.
Here’s an example. Ben and Holly own an apartment with a mortgage of $400,000 owing and have $200,000 worth of equity. They find a new family home they want to buy for $900,000 and want to use their $200,000 worth of equity to put towards the purchase. Unfortunately, they haven’t yet sold their apartment and the auction for the new home is this weekend.
If Ben and Holly decide to utilise bridging finance, then they will have a loan of $400,000 on their apartment, a bridging loan of $200,000 and a loan of $700,000 on their new home bringing their total debt to $1,300,000. Once their old property is sold, the $400,000 apartment mortgage and $200,000 bridging loan will be repaid, leaving them with a single loan of $700,000.
Here’s where it gets a little complicated though.
The main barrier to bridging loans is that banks put significant buffers in place just in case the current home sells for less. Some banks will do a valuation on the current home and take 15% off the value before working out if you have enough equity. Once the buffer is factored in, along with room for capitalised interest, purchasing costs and sale costs, it can be quite difficult to get a bridging loan.
In our above scenario, it would mean the Ben and Holly’s property would need to be worth around $800K for a $200K bridging loan to work.
When is a bridging loan a good idea?
Bridging finance is a handy tool if you have found a house you love but don’t have access to your equity to put towards the purchase. You still need to have a deposit available, this could be cash you’ve saved or funds you’ve accessed via a redraw facility.
Once you’ve sold your property, you generally have 12 months to pay off the ‘bridge’.
When is this type of loan not suitable?
A bridging loan is not for everyone. The interest charged on a bridging loan is usually higher than the interest charged on a standard home loan, so it’ll cost you more if you need this type of finance.
Something to bear in mind if you decide to buy before you sell, is that you will be paying two mortgages at once. The one on your old home and the one on your new home. A bridging loan doesn’t cover any of these costs. It is simply used in lieu of the equity you are going to be using once your previous home sells. Therefore, not only do you pay higher interest on the bridging finance (around 5.5% at the time of writing) but you are up for the cost of two mortgages.
A bridging loan can put pressure to sell your current property too, as once you take out the loan the clock starts ticking and you have 12 months to repay the bridging loan.
One final aspect to consider is if your current property sells for less than you thought. You may find yourself in a position where you must pay back the bridging finance with funds other than the sale proceeds. This doesn’t happen often as the banks ensure you have a protective buffer in place and simply won’t lend you the money if there’s any question of your ability to repay the loan.
Not sure whether you need a bridging loan?