What is a bridging loan?

A bridging loan enables you to purchase your new property before your existing one is sold.

In a perfect world, you would be able to align the dates you sell your existing home and purchase your new one so that there’s no overlap; pigs are more likely to start flying than this coming to fruition in real life. With general market uncertainty, price fluctuations and stagnating auction clearance rates, among myriad factors, many buyers are finding their new, dream home, without having sold their existing home. While this isn’t an ideal situation to find yourself in, you’ll be happy to know there’s a solution, a bridging loan.

A bridging loan, as its name implies, serves as a bridge, enabling you to purchase your new property before your existing one is sold. A bridging loan provides you with the cash flow you need to move on a property at any time, without being held back by current home making the transition much easier.

Although bridging loans are not a new concept, they have seen a marked increase in popularity in recent years following banking deregulation. Before banking deregulation, bridging loans were viewed as being higher risk loans which meant the interest rates associated with them were extremely high. However, in recent years a number of lenders have developed bridging loans with standard variable rates of interest which have driven to rise of these loan types and made them a more viable option for home buyers.

How do bridging loans work?

When lenders calculate the size of your commitment, they look at the value of your new home in addition to your outstanding mortgage on your existing home and then deduct what they believe will likely be the sale price of your existing home.

For example, Price of New Home + Current Mortgage – Expected Sale Price of Existing Home = Your Ongoing Balance. The term, ongoing balance, represents the principal of your bridging loan.

Bridging loans are interest-only which is useful, especially while you are trying to juggle both properties because your monthly repayments end up working out to be less than if you were paying off the loan principal. Instead, the interest is compounded on a monthly basis on your ongoing balance at the standard variable rate and when you sell your existing home the amount then becomes the mortgage for your new property.

While interest rates are now lower than they have been previously for this type of loan, it’s still important to remember that you are still essentially carrying two mortgages and during this interest only period you’re not paying off the principal at all. And, while a bridging loan is a good option to tide you over while you sell your existing home, we do still advise that you do everything in your power to encourage the sale of your home, as the longer you’re on a bridging loan, the higher your interest bill.

Is a bridging loan right for me?

As with any loan, there are risks associated with bridging loans.

One of the biggest risk associated with a bridging loan is when the homeowner overestimates the likely sale price of their existing property which then means they fall short of the amount required to pay out their loan. However, by far the biggest risk when it comes to bridging loans is when a homeowner is not able to sell their existing property within the agreed upon timeframe. If you find yourself in this situation, you’ll likely face increased interest rates, and your loan will be brought back to a principal and interest basis, which is not the ideal situation.

The good news is though when your bridging loan is structured correctly with realistic timeframes and selling price estimates, a bridging loan can really take the pressure off you while you work to transition into your new home. This type of loan is not without risk, and it’s for this reason that we encourage all homeowners to do their research and seek financial advice they can trust to minimise the risk and stress