So you’ve found the perfect home and want to move into your new home quickly! A bridging loan can help you do just that.
These loans bridge the finance gap and can be attractive for homebuyers. So, what is a bridging loan, and how exactly do they work?
This simple guide will teach you everything you need to know about bridging loans, how your financial situation may benefit, and the potential risks.
What is Bridging Finance?
A bridging loan, also called bridging finance, is an interest-only, short-term loan. It acts like a bridge, covering the financial gap between your new property purchase and when you sell your existing home.
A bridging loan is a supplementary home loan that you can take out in addition to your existing home loan until the property is sold. Once your current home is sold, the loan gets closed. This means you’ll have two loans during the bridging period, and interest will be charged on both.
Lenders offering bridging finance typically calculate the loan size based on the amount of equity amount you hold in your current property. They are usually provided for a fixed term of 6-12 months. In most cases, it is six months if you’re purchasing an existing property and 12 months if you’re buying a new property.
It should be noted that bridging term extensions are available on a case-by-case basis.
Notably, the interest on bridging home loans is compounded monthly. So, the longer you take to sell your existing property, the more interest will accrue. Furthermore, lenders may charge you a higher interest rate if you aren’t able to sell your property within this timeline.
Who is Suitable for a Bridging Loan?
Bridging home loans can be of great help if you’re transitioning from one home to another and are waiting to receive proceeds from the sale of your existing property.
Bridging home loans are also suitable for home buyers looking to finance the building of a new home while continuing to live in their existing house.
At the same time, bridging finance may be an option only if you own a certain amount of equity in your existing house. Most lenders require a maximum Loan to Value Ratio (LVR) of 80% to offer home buyers a bridging loan.
Where you do not have sufficient equity in your home, some lenders may charge higher interest rates on bridging finance.
Types of Bridging Loans
Bridging loans differ based on their intended purpose. The main types of bridging finance are as follows:
Closed Bridging Loans
For this loan type, you agree on a date on which the sale of your existing property will be completed. You’ll have to pay the loan and any accrued interest and fees on this date.
Closed bridging loans are only available to home buyers who have exchanged contracts on the sale of their existing property at an agreed price and settlement date. This loan structure offers lenders more assurance and is considered less risky since exchanged property sales mostly proceed to completion.
Open Bridging Loans
An open bridging loan is suited for home buyers who have found a new property but don’t have a fixed date for exiting the bridging finance. This is because the property sale has not been finalised, and the home buyers may haven’t yet put their existing home on the property market.
In general, lenders consider these loans high risk. If you’re considering an open bridging loan, your lender will likely want to see the details of your new property. They may also require proof indicating that you are taking the steps necessary to sell your existing home.
Moreover, you’ll have to hold significant equity in your existing property with open bridging loans. By extension, it is advisable to have a robust alternative plan in place should the sale of your house fall through.
How Does a Bridging Loan Work?
Understanding how bridging loan works is critical before taking out one.
To begin with, your bank will determine your loan size by adding the property value of your new house to your current home loan. Next, the likely sale price of your existing home will be subtracted from this total. Finally, this ongoing balance (or end debt) indicates the principal amount of your bridging home loan.
Your bank or lender will do the property valuations. The costs typically range between $200 to $600 per valuation.
After determining your principal amount, your lender will now evaluate your capability to make your loan repayments on this end debt.
Till you sell your existing home, most lenders will capitalise interest-only repayments on your peak debt during the bridging period. So you won’t have to stress about repaying two different home loans. Instead, you’ll only have to make principal and interest (P&I) on your current mortgage.
After the sale of your first property is completed, the net proceeds, i.e., your selling price minus costs, including selling agent’s fees, etc., are used to lower your peak debt further.
Once your existing property is sold, you continue with your normal home loan repayments, along with the compounded bridge loan interest, on your new loan. During the bridging term, both your properties will be used as security amid the sale and purchase process.
Bridging Loan Criteria
In Australia, bridging loans are growing more popular. Apart from traditional big banks, more and more non-bank lenders, fintech, and private lenders are now offering bridging loans.
To qualify for a bridging home loan, lenders usually require you to match the following criteria:
Maximum End Debt
Where an end debt is expected, the maximum end debt cannot exceed your new property value.
To apply for a bridging loan, in most cases, you’ll need a maximum LVR of 80% (i.e., a 20% deposit) to apply. However, you may get a bridging loan with a maximum LVR of 85% in some instances, but it will also include the settlement, application and legal fees.
On the other hand, some lenders will be keen to see you have at least 50% equity in your current home to qualify for a bridging loan. So ultimately, it depends on the lending criteria.
Maximum Loan Term
Whether a closed or open bridging loan, your current home must be sold in 6-12 months. So, you’ll need to factor in the time it will take to sell your property when considering this type of loan.
Standard Serviceability Requirements
As with a standard home loan, you must provide satisfactory evidence of your financial situation. This includes your current income, employment status, expenses and other supporting documents required by your lender.
Sale Contract for Existing Property
Sometimes, your lender may seek evidence that your current home has been sold. For example, you may have to submit a copy of the sale contract as a pre-requisite for bridging loan approval.
Some banks offer bridging loan options only for their standard variable rate home or investment home loan products. Therefore it’s essential to compare home loan products to get the most suitable deal for you.
In general, during the bridging period, you will not be able to use the redraw facility on your bridging loan.
Bridging loans are typically unavailable for construction loans and company or strata title purchases.
Bridging Loans in Practice
This bridging loan scenario will give you a better idea of a bridging loan works and can be used to finance your new home.
Millie and Thomas plan to sell their current property. The current loan balance on their home is $250,000.
They see a new property, which they really like. And, though they have yet to sell their home, they want to purchase the new property before someone else picks it up.
Millie and Thomas apply for a bridging loan. They get their approvals, and their $250,000 loan becomes the bridging loan. Their maximum loan term is seven months.
They also get approved for a $500,000 home loan for their new home. Now, the combined debt including the existing mortgage new loan i.e., peak debt remains $750,000 ($250,000 +$500,000 = $750,000).
Millie and Thomas opt for interest-only repayments during the bridging period and sell their house for $350,000 within seven months.
The proceeds from the sale are used to pay their initial loan balance on the house sold.
They now have $100,000.
Millie and Thomas put this $100,000 towards paying off their home loan. At this point, their home loan balance has reduced to $400,000 ($750,000- $250,000-$100,000 = $400,000).
With the property sold, the couple now switch their home loan from interest-only to principal and interest repayment.
How Much Does a Bridging Loan Cost?
The cost of a bridging loan depends on a few different factors. These have been summarised below to help give you a better idea and compare other lenders.
The longer you take to sell your property, the more the cost of your bridging loan. The reason is that the interest is calculated daily and capitalised every month.
Property Valuation Costs
You’ll have to bear the costs of two property valuations. This includes your existing property and the new property valuation charges, which can set you back anywhere between $200 - $600 per valuation.
Purchasing and Selling Costs
You should typically budget 5% of your property value as purchase costs. Likewise, when selling your property, the agent fees, marketing costs, etc., usually works up to 3% of your selling price.
Furthermore, where your end debt ranges between 80%-85% of your new property value, your lender will make you pay Lenders Mortgage Insurance ((LMI).
Loan Application Fees
While some lenders have a waiver on application fees, most bridging loan application fees cost up to $1,000.
Bridging Loan Pros and Cons
You must assess the pros and cons of any financial decision, and a bridging loan is no different. It helps to clearly understand what these loans are before committing.
Pros of Bridging Loans
- Purchase your new home without delay: You can proceed with confidence once you’ve found a new home. You don’t have to wait around for months first to sell your home and get the financing you need.
- Skip the stress of renting: You can minimise the stress of renting while you’re waiting to buy your home. However, it’s advisable to do your math - sometimes, renting and moving costs may be less expensive than a bridging loan. Our Rent Vs Buy Calculator can help you determine whether to rent or buy your home.
- Reduce interest costs: Making payments during the bridging period helps reduce the interest payable when you sell your property. Moreover, if the property value and equity are sufficient, you can add other upfront costs, such as stamp duty, legal fees, etc., to your bridging loan. Again, this can help you save a lot of money.
- Capitalised repayments: Many lenders allow interest to be capitalised. It is paid once the property is sold. You will only have to keep paying your current mortgage. You don’t have to stress managing two home loans.
- Avail standard interest rates: While some lenders charge higher interest on bridging loans, you’ll be able to find lenders who will offer you standard variable interest rates.
- Avoid selling in a haste: You can avoid the pressure of having to sell your home in a hurry and wait reasonably long enough to find a suitable buyer willing to pay the right price for your home.
Cons of Bridging Loans
- Paying compounded interest: Since you don’t need to make any payments on your bridging loan, the interest is added to the balance. In this way, so you will eventually be paying interest on this interest. The longer your property takes to sell, the more interest will accrue on your loan.
- No redraw: With bridging finance, you won’t be able to access redraw facilities on repayments made during the bridging period.
- Interest rates increase: There are penalties for extending beyond the bridging period. Likewise, the longer it takes to sell your property, the more interest you’ll have to pay on your loan. Therefore, you must be aware of your market and how long your property will take to sell.
- Property valuation costs: You will have to do a valuation of your existing and new property. Most valuations will cost between $300 and $600 per property.
- Termination fees: You may have to switch if your current mortgage lender does not provide bridging loans. This could lead to early exit fees, especially if switching to a fixed-rate loan.
- Risk of lower sale price: If your property goes for less than you planned, you may have a larger ongoing loan amount. This could severely dent your financial situation.
Bridging Loan vs Mortgage
You may want to know if a bridging loan is the same as a mortgage. Of course, they both provide finance for property buyers, but that’s where the similarity ends. Here’s a quick peek a the key differences:
A mortgage is a long-term loan used to finance a home purchase. Homebuyers usually make repayments over 25 to 30 years. On the other hand, a bridging loan is a short-term loan - generally offered for one year or less- and is used to finance the purchase of a property until the homebuyer can arrange permanent financing.
Bridging loans typically get approved in 7-14 days. At the same time, it chiefly depends on your lender’s assessment criteria. Some lenders with faster turnaround times may get you pre-approved within 5-10 days.
In contrast, in Australia, the average time from your home loan application to formal approval and settlement typically takes between 4- 6 weeks.
Interest Costs and Interest Repayments
Bridging loans carry higher interest rates than mortgage interest rates.
Further, mortgage repayments are usually made every month. Bridging loans can be repaid as lump sum payments once the term expires.
In a nutshell, bridging loans are ideal for those who are cash-poor and awaiting funds from a new mortgage or their property sale. So if you’ve seen a property you like, where a mortgage might not be approved in time, a bridging loan can help you buy the property while you sort out your finances.
Is a Bridging Loan a Good Idea?
Besides assessing the pros and cons, do your research or connect with specialist brokers before deciding on one.
Also, ask yourself the following questions before committing to a bridging loan. It may help you avoid financial difficulty down the road.
Do My Circumstances Require a Bridging Loan?
Unlike cities where properties get sold quickly, bridging loans are more beneficial in suburban locations where properties are more difficult to sell.
Will I Sell My Property in Time?
Do your research on the clearance rates in your area to get an approximate idea of how long it takes to sell property in your neighbourhood. You may have to pay penalties and higher interest rates if you cannot sell your property in the bridging period.
Do I Have a Sufficient Deposit or Equity?
Bridging finance isn’t covered by LMI. So, you must have at least 20% of your peak debt as a deposit to buy your new house. Moreover, your lenders will look at your equity in your existing home. The more equity you have, the more your borrowing power.
Will I Have End Debt?
Lenders offering bridging finance generally do so with the expectation of an end debt. But if you don’t have end debt, for example, when you are downsizing, the rates may be higher.
Finally, remember that a bridging loan is a short-term finance solution. So, if you require long-term financing, this type of loan may not be ideal.
Alternative Loan Options
If you do not qualify for bridging finance, the next best alternative would be to apply for an additional home loan to buy your new property.
However, to do this, you should qualify for a loan and have the capability to make both your mortgage repayments.
Handy hint: Consider the size of your initial mortgage and the interest you’re paying. Next, compare it to the potential rent you would have to pay if you cannot sell your existing home before purchasing a new one.
How Joust Can Help Your Home Loan Journey
Bridging loans removes the pressure to align everything in the property sale and purchase process. The Live Auction feature on the Joust Marketplace can help you view and compare real-time bids from reputed Aussie Lenders.
Instead of approaching lenders individually for home loan offers, the Live Auction provides you with the security and convenience of choosing a fair deal from the comfort of your home. And with no obligation to accept an offer, the Joust Marketplace is a must-try.
How Much Deposit Do I Need For a Bridging Loan?
Maximum LVR requirements generally apply for bridging loans. You’ll typically need to put down at least 20% of the peak debt as a deposit to qualify for an eligible home loan. Some lenders may allow you to access your equity as security for the deposit towards your new property.
How Hard is it to Get a Bridging Loan?
To qualify for a bridging loan, your total loan LVR for peak debt during the bridging period should be 80% or less. If your financial situation does not meet the eligibility criteria, you may find it challenging to secure a bridging loan.
What is the Typical Interest Rate on a Bridging Loan?
The interest rates for bridging loans are generally much higher than regular mortgages. As with other home loans, the bridging interest rates vary from lender to lender.
For example, at the time of writing this article, the interest rate for a bridging home loan with offset by the Australian Mutual Bank is 6.15 % pa (variable). On the other hand, the interest rate for a P&N Bank Bridging Loan is 7.52% (variable).
Therefore, you should shop around to get the best deal on a bridging loan.
How Long Does it Take to Get a Bridging Loan?
Bridging loans usually take 7-14 days to get approved, depending on your lender’s criteria. However, in the case of some lenders with faster turnaround times, you could even get pre-approved within 5-10 days.
How Long Can You Have a Bridging Loan For?
Once you get approved, the general term of a bridging loan is usually six months when buying a new property and 12 months when constructing a new property.
The information in this article is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.