Introduction
Buying a new property can be an exciting yet challenging journey. It often requires significant financial investment, from down payments to closing costs. In some cases, you may need immediate funds to purchase your new property while waiting to sell your current one. This is where a bridging loan can come in handy. In this blog, we will discuss what a bridging loan is, how it works, and why it may be the right choice for you.
Key takeaways
- A bridging loan is a short-term financial tool that bridges the gap between selling an existing property and purchasing a new one.
- Bridging loans come in two types: closed with fixed repayment dates and open with flexible repayment terms.
- You need a high loan-to-value ratio, a clear repayment plan, and financial stability to get a bridging loan.
- High interest and the unpredictability of the property market underscore the need for cautious bridging loan consideration.
What is a bridging loan?
A bridging loan is a short-term financial instrument primarily used to "bridge" the monetary gap from selling an existing property to purchasing a new one. This type of loan is highly regarded for its ability to enable borrowers to make advance payments on acquiring new properties while awaiting the sale of their current ones. This is especially useful for borrowers who need quick access to funds and cannot wait for the lengthy approval process associated with traditional loans.
How does bridging loan work?
A bridging loan is a type of short-term financing that consists of three components:
- The outstanding loan balance on your existing home.
- The purchasing price for your forthcoming home.
- The interest and any additional fees are tied to the loan.
Let's look at an example to understand better how bridging loans work if you’re looking to buy and sell a house simultaneously.
Example:
Let’s say your house is valued at $500,000. You have an outstanding mortgage of $300,000, which leaves you with $200,000 in equity. You've found a new property you wish to purchase for $800,000 but want to avoid the pressure of selling your current home quickly. To navigate this situation, you should consider taking out a bridging loan.
Here’s how it works:
- Current Home Value: $500,000
- Outstanding Mortgage on Current Home: $300,000.
- Equity in Current Home: $200,000
- Purchase Price of New Home: $800,000
To secure the new home without selling your current one immediately, you transform your existing $300,000 mortgage into a 12-month bridging loan. At the same time, you are approved for a new $600,000 mortgage for your new house, which raises your total debt to $900,000, the maximum amount you will owe during this transition.
You use the $200,000 equity from your current home as a down payment for the mortgage on the new property. During the bridging loan's term, you opt for interest-only payments on the bridging loan and the new mortgage to stabilise your overall debt.
After six months, you sell your original house for $500,000. From this sale, $300,000 is ultimately used to pay off the bridging loan, and the remaining $200,000 is put towards reducing your new house's mortgage.
Consequently, your mortgage balance on the new home comes down to $600,000. You can then switch to a repayment plan that includes both principal and interest to pay off your new home loan gradually.
Type of bridging loans
Bridging loans are typically short-term financial solutions, and lenders usually distinguish between two main types based on how they define the repayment deadline (also known as the time you're expected to return the borrowed funds).
A closed bridging loan specifies a repayment date or strategy agreed upon by both the lender and the borrower. This arrangement provides more predictability, often resulting in lower interest rates for the borrower. However, lenders will require a solid exit plan and evidence of sale to approve a closed bridging loan. This type of bridging loan is usually best suited for borrowers who have already finalised the details of their property sale.
Conversely, an open bridging loan is characterised by its flexibility regarding the repayment date. This lack of a set deadline can lead to higher interest rates due to the increased uncertainty for the lender. This option might be chosen if, for instance, you're unsure of when you'll be able to sell your current home and, therefore, cannot predict when funds will be available to repay the loan.
What are the requirements for obtaining a bridging loan?
To prepare for a bridging loan, the requirements are similar to those for a standard home loan but with specific considerations based on the lender and the bridging loan product. Key factors include:
- Loan-to-value ratio (LVR): This is essentially the size of your loan compared to the value of your property, often required to be 80% or more. It depends on how much you can borrow and the equity you have.
- Loan term: It refers to the duration you have to sell your current property, usually ranging from 6 to 12 months for most bridging loans.
- Loan features: Some bridging loans might restrict certain features, such as redraw facilities.
- Property types: Bridging loans might not be available for certain purchases, such as vacant land or investment properties.
- Financial documentation: As with any loan, lenders will require proof of income and economic stability to assess your ability to repay the loan. In addition, they may also request information on the sale price of your current property and any offers you've received from potential buyers.
- Exit strategy: Lenders will want assurance that you have a plan to repay the bridging loan, whether through the sale of your current property or other means.
- Additional costs: It's essential to factor in any additional costs associated with a bridging loan, such as valuation fees, legal fees, and early exit fees, if you decide to pay off the loan before its term ends. It's crucial to consider these costs carefully and factor them into your budget when planning for a bridging loan.
Need more clarification on the requirements for obtaining a bridging loan?
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What are the pros?
Bridging loans offer borrowers a variety of benefits, making them an attractive option for those seeking temporary financial assistance. Some of these advantages include:
Bridging loans provide the unique advantage of allowing you to purchase your next property immediately. This is especially beneficial if you've found the home of your dreams and are concerned about it being sold to someone else in a competitive market.
By obtaining a bridging loan, you can extend an offer and finalise the acquisition of a new property without first selling your existing home. This ensures that you secure your ideal property without the risk of it being snapped up by another buyer.
One of the key benefits of a bridging loan is its flexibility in selling your existing property. Instead of being pressured to quickly accept an offer below market value just to facilitate the purchase of a new home, a bridging loan allows you to hold onto your current property until you receive an offer reflecting its true worth. This can potentially lead to a more profitable sale.
Bridging loans can be structured in a way that capitalised the interest. This means you won't have to make ongoing interest payments during the loan term. Instead, the interest accrues and is paid off when you sell your current home. This feature is particularly advantageous for those who wish to avoid the financial burden of paying two mortgages simultaneously, as it allows for better cash flow management during the bridging period.
Bridging loans can offer access to more substantial sums of money than you might be able to obtain through more traditional types of financing. This increased borrowing capacity can be crucial in enabling you to purchase a new property that meets your needs or desires, without having first to sell your existing home. This can be particularly important in high-value real estate markets or when looking to buy a property that requires a significant investment.
Finally, bridging loans can help you avoid the inconvenience and additional cost of moving into a rental property while you wait for your current home to sell and the purchase of your next house to be processed. By bridging the gap between the sale of your current home and the purchase of your new one, you can move directly from one to the other without needing a temporary housing solution. This saves money on rent and avoids the hassle of moving twice and the emotional strain of living in a transient state.
What are the drawbacks of bridging loans?
While bridging loans offer valuable opportunities, it's essential to be aware of the risks associated with this loan. Here are a few of them:
Bridging loans typically come with higher interest rates compared to standard home loans. This is because they are short-term and carry more risk for the lender. The increased interest charges can significantly add to the total cost of the loan, especially if the sale of your property takes longer than expected.
The property market is unpredictable, and prices can fluctuate. If the market goes down during the period of your bridging loan, you might end up selling your property for less than anticipated. This could lead to a financial gap where the proceeds from the sale might not fully cover the bridging loan amount, leaving you with additional debt.
Bridging loans have stricter eligibility requirements compared to other types of loans. Lenders often require a strong credit history, stable income, and significant equity in your current property. These criteria can make bridging loans less accessible for some borrowers.
Is it worth considering a bridging loan?
The decision to take out a bridging loan ultimately depends on your circumstances and goals. If you're confident in your ability to sell your current property quickly and at a desirable price, a bridging loan can be a valuable tool for securing your next home without waiting for the sale process.
However, it's essential to carefully consider the risks involved and ensure that you can comfortably manage the loan repayments before deciding. Consulting with a financial advisor or mortgage broker can also provide valuable insight into whether a bridging loan is the right option for you.
Additionally, it's important to thoroughly research and compare different lenders and their loan terms before committing to a bridging loan. By carefully weighing the pros and cons and fully understanding the loan terms, you can determine whether a bridging loan is worth considering in your particular situation.
Some frequently asked questions about bridging loan
- What is the typical loan term for a bridging home loan?
- Will obtaining a bridging loan impact my credit score?
- What is the interest rate for bridging finance?
- Is it easy to secure a bridging loan quickly?
Ans: Bridging home loans are short-term, typically lasting from a few months up to one year.
Ans: Like any loan or credit, a bridging loan can affect your credit score. Diligent repayments can mitigate negative impacts, but missing payments may harm your score.
Ans: Bridging finance rates are typically higher than standard mortgages, usually between 5-6%, while regular mortgage rates start just over 5%.
Ans: Yes, with ZedPlus, obtaining a bridging loan is straightforward and swift, with the potential to receive approval in two to three days, provided all necessary documentation is submitted without delay.
Conclusion
Now, you better understand what bridging loans are, how they work, and their advantages and disadvantages. It's crucial to consider your financial situation and goals carefully before deciding if a bridging loan is the right option.
Additionally, it's essential to thoroughly research and compare different lenders and their loan terms to find the best solution for your needs. If you're still unsure, consulting with a financial advisor or mortgage broker can provide valuable insight and guidance in making the best decision for your unique circumstances.
At ZedPlus, we're here to simplify the process for you. With access to over 50 lenders, we're in a great position to offer you competitive bridging loan options tailored to your needs. We will also provide expert guidance and support throughout the application process, making achieving your dream of owning a new home easier.
Moreover, as qualified tax agents, we are well-positioned to guide you on the tax implications of buying and selling new and existing properties. ZedPlus stands out with its comprehensive suite of mortgage broking and tax agent services, all under one roof. So, don't let the fear of selling your current property hold you back from purchasing your dream home – reach out to us today and start your journey toward homeownership!