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 is no overlap. Pigs are more likely to start flying before this happens. With general market uncertainty, price fluctuations and stagnating auction clearance rates, among a myriad of other factors, many buyers are finding their new dream home without having sold their existing one. This is far from the ideal situation, but there is a solution: a bridging loan.
As its name implies, a bridging loan 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 onto another property at any time, without being held back by your 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 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, proliferating the market and making 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. Then, they 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’ interest-only feature is useful, especially when 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 ever for this type of loan, it is still important to remember that you are essentially carrying two mortgages and during this interest-only period you are not paying off the principal at all. A bridging loan is a good option to tide you over while you sell your existing home, but we still advise that you do everything in your power to encourage the sale of your home, as the longer you are on a bridging loan, the higher your interest bill. Choosing and managing a bridging loan can end up being a costly and ineffective endeavour, so it is important to seek out an expert you can count on for the right advice.
Is a bridging loan right for me?
As with any loan, there are risks associated with bridging loans.
This type of loan is not without risk, and it is 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. A notable risk associated with a bridging loan is when the homeowner overestimates the likely sale price of their existing property. Subsequently, they fall short of the amount required to pay out their loan. However, the biggest risk by far when it comes to bridging loans is when a homeowner is not able to sell their existing property within the agreed upon time frame. If you find yourself in this situation, you will likely face increased interest rates, and your loan will be brought back to a principal and interest basis which spells out big problems financially.
Hence, it is vital that your bridging loan is structured correctly with realistic time frames and selling price estimates. When done right, a bridging loan can really take the pressure off of you while you make the plans to transition into your new home.