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Bridging loans

Bridging finance covers the gap between buying your new property and selling your old one.

Bridging home loans can be used by home buyers who have found a home they want to buy but haven’t yet found a buyer for their previous home. Bridging loans can generally be organised very quickly and can help borrowers who need to move on securing the purchase of a new property.

How do bridging loans work?

Bridging loans are calculated on the amount owing on your current mortgage, plus the purchase price of your new property. This figure is known as your “peak debt”. For example, if you owe $250,000 on your current mortgage and purchase a new property for $600,000, your peak debt is $850,000.

Your lender then subtracts the likely sale price of your existing home from this figure. Generally, the lender builds in a buffer to consider the possibility of selling at a lower price and then arrives at your ongoing balance—this is the amount of your bridging loan.

Bridging loans are interest-only loans, meaning you only owe for the interest charged on your ongoing balance. Lenders usually capitalise on this interest, making it payable upon the sale of your existing property. At this point, the bridging loan reverts to a standard mortgage.

The two main types of bridging loans are closed bridging loans and open bridging loans.

Closed bridging loans

Closed bridging finance has a pre-agreed date by which the property is sold and the loan repaid. Therefore, a closed bridge is only available to homebuyers who have already exchanged on the sale of their existing property.

How do I get a closed bridging loan?

To get a closed bridging loan, you typically need at least a 20% deposit. You also need to provide all the information about both the properties involved.

These loans typically have application and monthly fees that can add to your costs, so be sure to factor them in.

Open bridging loans

An Open Bridge differs in that buyers take them out when they have found their perfect property but haven’t found a buyer for their existing home. An open bridging loan is one with no set period in which to sell your property. While a closed bridging loan has a predetermined time frame for your home to be sold, typically six months, an open bridging loan does not.

Lenders are often hesitant to offer open bridging loans and expect to see details about the new property and proof that you are actively marketing your current home. Lenders also insist you have a significant amount of existing equity in your existing property and an exit strategy if the sale falls through.

When would I use an open bridging loan?

You use an open bridging loan if you have yet to exchange contracts on the sale of your current property or if you expect a settlement delay.

How long do bridging loans last?

Bridging loans are generally offered for up to 6 months, though in some cases, lenders may provide a bridging period of up to 12 months. Most bridging loans are for purchasing an established property, though some lenders allow bridging loans to construct a new property.

However, you still need a 20% deposit for your new property, as lenders mortgage insurance (LMI) doesn’t cover bridging loans. If you do not have funds readily available, then a deposit bond is one alternative. A deposit bond is a substitute for a cash deposit that guarantees the purchaser will pay the total purchase amount by the settlement date.

When applying for a deposit bond, your deposit bond provider makes an independent assessment. Providers can issue bonds for up to 48 months, but the shorter the period, the lower the cost to the borrower.

What else do I need to be aware of?

While there are many advantages with bridging loans, there are some disadvantages too. In some cases, people may find it harder to sell their existing homes as quickly as they thought, which means you’ll pay a lot more interest as you’re now repaying two mortgages.

Another catch is some people may be forced to sell their existing homes for a lower price than initially intended. Others may find they don’t have sufficient equity in their homes to qualify for a bridging loan.

Advantages

  • Avoid paying for two home loans. The main feature of a bridging finance loan is that it allows you to avoid taking out another full mortgage.
  • Interest-only repayments. While you have the bridging finance loan, you don’t have to make total repayments on both loans. Instead, you have to pay off your regular mortgage as you have been, and you only have to pay the interest portion of the repayments on the bridging finance.

Disadvantages

  • You need to know how much your home will sell for. When you get a bridging finance loan, you need to accurately predict how much your old property will sell for. If it doesn’t sell for as much as you plan, then you may find that you don’t have enough money to pay off the loan and buy the new home.
  • The longer the sale takes, the more interest you pay. Unfortunately, it can be hard to predict how long it will take to sell your old home. If the old house takes a long time to sell, you have to pay more in interest.
  • You could face break costs. For example, if your current mortgage is a fixed-rate mortgage, you may have to pay break costs for exiting the loan early.

Other examples of where a bridging loan can be beneficial

Developers often obtain a bridging loan to carry a project while permits are approved. Since the project is not guaranteed, the loan may have a higher interest rate and be from a specialised lending source that accepts the risk. However, once the project is fully entitled, it becomes eligible for loans from more conventional sources in more significant amounts, over extended periods and with lower interest rates. Developers then obtain a construction loan to take out the bridge loan and fund the completion of the project.

A business can also use a bridging loan to ensure continued smooth operation when, for example, one senior partner wishes to leave whilst another wishes to continue the business. The bridging loan could be made based on the value of the company premises allowing funds to be raised via other sources, for example, a management buy-in.

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