Property sales don't always happen instantly and there may be a delay with the funds. This is when a bridging loan can help with your finances.
When you're part of a property chain, you want your sale and purchase to go through simultaneously. You want everything to run smoothly and no financial gaps to appear. Unfortunately, there are occasions where a delay between sale and purchase lead to a major cash flow problem. A problem that would cause you to miss out on your purchase unless you were able to raise the funds another way. Luckily there is a solution and it's called bridging finance.
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What is bridging finance?
Bridging finance (e.g. a bridge loan), is a type of finance that can help businesses and investors manage the cash flow gap that can occur between the purchase of one asset and the sale of another. With the ability to be organised within 2-3 days, bridging finance can also be useful for business purposes such as: buying business equipment, unexpected business costs or for expanding and acquiring new business; and for personal use to buy shares, pay bills and most predominantly invest in or build property.
Bridging home loans can also 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.
A bridging loan can be useful to help manage the fees and charges associated with purchasing and selling property and normally lenders will agree on terms no longer than 12 months.
What are the different types of bridging loans?
The two main types of bridging loans are known as: Closed Bridge and Open Bridge.
Closed Bridging Finance is aptly named because the date for exiting the loan is pre-agreed upon as the date that the bridging finance will be repaid by. A closed bridge is only available to homebuyers who have already exchanged on the sale of their existing property, since very few sales fall through after exchange and is therefore less risky to the lender.
An Open Bridge differs in that it is taken out by buyers who have found their perfect property but don't have an exact date to exit the bridging finance because they haven't put their existing home on the market. In this instance, the bank is likely to ask a lot more questions and need information that supports the answers. The lender will expect to see the property details of the new property and want proof that your current home is being actively marketed. It will also insist you have a lot of existing equity in your current property and an exit strategy in case the sale falls through. Twelve months is the standard limit for an open bridge and as long as you have paid the interest during the period and the property hasn't collapsed, then the bank will most likely negotiate an extension if needed.
What are the alternatives to bridging loans?
A deposit bond is another alternative to bridging loans. These can help borrowers put a deposit on their new property, allowing them more time to arrange their own alternative finance. Deposit bonds are ideal if you're buying a home but have money tied up in another property investment.
How to use bridging finance effectively
- A bridging home loan can be useful if you want to stay in your old home while building rather than having to sell your old home first and renting while the building is taking place.
- Once your building is finished and ready for you to move in you can then put your old house on the market for sale with vacant possession.
- You have avoided having to move into the rental property during the interim and moving again into your new home on its completion.
- If you are exiting a fixed loan there will inevitably be extra costs as well as establishment charges on the new loan, valuation fees and legal fees etc.
- Your lender is in effect taking on the risk of two mortgages by covering the gap between settlement and the new purchase.
There is normally a pretty strict criteria imposed before bridging finance is approved by a lending authority. Conditions can include:
- Unconditional sale on existing property.
- Restrictions on settlement terms.
- Other conditions on a case-by-case basis.
How do I make repayments?
Bridging loans have a higher risk so than regular home loans, so the interest rate can be higher.
Your ability to repay the end debt is how your loan serviceability will be calculated. The end debt is the remaining loan balance, once your existing property is sold and the proceeds from the sale have been used to repay the bridging loan.
You'll typically have a period of 6-12 months in which to sell your existing property. Managing two mortgages at once is a big financial burden for most people, so in order to make bridging finance affordable most lenders don't require repayments during this period.
What are the restrictions with bridging loans?
While there are many advantages with bridging loans, there are some disadvantages too. In some cases, people may find it is a little harder to sell their existing homes as quickly as they thought, which means you'll be up for a lot more interest since you're now paying off two mortgages.
Another catch is some people may be forced to sell their existing home for a lower price than was originally intended; so to combat the problem of out of control interest, you should consider placing short-term tenants into the property to help keep your interest costs covered while you're trying to sell. Others may find they don't quite have sufficient equity in their homes to qualify for a bridging loan.
What are the pros and cons of a bridging loan finance?
- Avoid taking out another loan. The main feature of a bridging finance loan is that it will allow you to avoid taking out another loan. Furthermore, the bridging finance loan will allow you to avoid having to pay two loans off at the same time.
- Interest-only repayments. While you have the bridging finance loan you will not have to make full repayments on both loans. You will have to pay off your regular loan as you have been and you will only have to pay the interest portion of the repayments on the bridging finance.
While the bridging finance loans have a variety of advantages they do come with some disadvantages. The disadvantages of bridging finance are:
- You will need to know how much your home will sell for. When you get a bridging finance loan you should be able to accurately predict how much your old property will sell for. If it does 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 will pay. It can be hard to predict how long it will take to sell your old home. If the old home takes a long time to sell then you may find that you will have to pay a lot of money in the interest repayments.
Bridging Finance Hypothetical Examples
Bridging finance can be used in a number of different ways to minimise the risk of having two properties under finance.
Buying a new property
Sandy has a $250,000 mortgage on a $500,000 house and wants to buy a new home worth $400,000 plus costs of $50,000, which brings the new purchase cost to $450,000. Her new bridging loan will cover the initial $250,000 to pay out the existing mortgage and also the $450,000 for the new purchase bringing her total loan to $700,000.
Once the property has been sold (in this case for $500,000) this amount (is then put towards the mortgage which consists of the original $700,000 loan + capitalised repayments. This reduces the mortgage to $200,000 + capitalised repayments. She can then continue to make standard loan repayments with a standard mortgage.
Other examples of where a bridging loan can be beneficial:
A bridging loan is often obtained by developers to carry a project while permits are approved. Since the project going ahead is not guaranteed, the loan may have a higher rate of interest and be from a specialised lending source that will accept the risk. Once the project is fully entitled, it becomes eligible for loans from more conventional sources in greater amounts, over longer periods and with lower interest rates. A construction loan would then be obtained to take out the bridge loan and fund completion of the project.
A bridging loan can be used by a business to ensure continued smooth operation during a time 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.
A property was inherited and needed some renovations to realise its true market potential. Whilst the stripping out of the kitchen and bathroom was being done, the owner applied for a mortgage. Unfortunately, the surveyor deemed the property uninhabitable due to the renovations and the owner was unable to get a mortgage. Instead, the owner applied for a bridging loan, which enabled her to completely renovate the property. As soon as this was done, the owner was able to go back to her mortgage broker and obtain one and start paying her bridging loan back.
Frequently asked questions about bridging loans
How are repayments calculated during the bridging period?
While the sale of the existing home goes through, the minimum repayments are usually calculated on an interest-only basis. Depending on your lender you may be able to capitalize all repayments until the sale is completed but remember this option will cause your Peak Debt to increase and therefore increase the overall interest you will pay.
Wherever possible, making some repayments is recommended so that if you do have difficulties in selling your property, you will not have an additional 6 months repayments added to your loan amount (instead, the amount to be added to your loan will be reduced by whatever you have already repaid). Use our Basic Loan Repayment Calculator to work out how much your potential minimum repayments will be so that you can anticipate the changes ahead.
Do I keep making repayments during the bridging period?
Your lender may allow you choose either to capitalise your repayments (add them to the total amount of the loan), or continue to pay them. If you continue to make repayments, this will stop the total amount of the loan ballooning and limit the amount of additional interest being charged. If you are unsure as to whether to keep making repayments during the bridging period, talk to your local broker and he/she will advise you on the appropriate course of action that will suit your current financial circumstances.
Are there limits on how long I can take out bridging finance for?
You will normally have six months to sell the existing property or 12 months if a new property is being constructed. If the property has not been sold by that time, the loan will be reviewed and new arrangements may need to be put in place. Remember that a standard settlement in some states can take up to 6 weeks so this needs to be taken into consideration when calculating the bridging period. If you are unsure of how to calculate the bridging period and estimate the impact that it will have on your loan,consult with your local broker.
Are there limits on how long I can take out bridging finance for?
You will normally have six months to sell the existing property or 12 months if a new property is being constructed. If the property has not been sold by that time, the loan will be reviewed and new arrangements may need to be put in place.
Remember that a standard settlement in some states can take up to 6 weeks so this needs to be taken into consideration when calculating the bridging period.
If you are unsure of how to calculate the bridging period and estimate the impact that it will have on your loan,consult with your local broker.
If I am getting bridging finance, do I need to arrange a deposit on the second property?
Yes. 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 full purchase amount by the settlement date. Institutions providing deposit bonds act as a guarantor that payment will be made. They are generally used when cash isn't readily available for a deposit.
You can apply for a deposit bond once you have the formal approval from the lender, or if you can show that you have access to funds from another source such as shares.
When applying for a deposit bond, an independent assessment will be made by your deposit bond provider. Bonds can be issued for a period of up to 48 months, however the shorter the period the bond is required, the lower the cost to the borrower. A bond for a 10% deposit on a $500,000 property will typically cost around $600.
If you need help with the arrangement for a deposit bond, talk to one of your local Mortgage Choice brokers. They will be more than happy to assess your current financial situation and will make appropriate recommendations.
How can I work out if it's cheaper to sell my property first and rent, or buy somewhere new first and take out bridging finance?
That will depend on the rental market in particular and the state of the housing market generally. It will also depend on the size of your mortgage and how much interest you're paying as compared with the type of property you might be looking to rent and the subsequent rental payments on this.
How long can I take out a bridging loan for?
Usually about six months for an established residence or 12 months for a new dwelling. This can be reviewed and extended under a new arrangement if found necessary.
Do I need to put a deposit on the second property if I am getting a bridging loan?
Yes. If you haven't got the funds readily available you may be able to obtain a deposit bond to hold you over. A deposit bond will need proof of assets such as shares etc.
Do bridging loans differ?
Yes. You have a wide choice available to suit your needs:
- Method one allows the lender to take over both properties which will leave you with just the one mortgage to worry about. You will then have from six to 12 months to sell your old property.
- Method two allows for a second loan to be taken out on your new property while the mortgage on your old property is retained. In this case you have to make repayments on both mortgages.
On the sale of your old property being completed the lender administering that loan is paid out in full and any balance is paid toward reducing the new mortgage. Bridging finance is always an option but it doesn't matter whether you are building or buying your next home, you will need to go into it with your eyes open.
Obtaining bridging finance will give you the opportunity of being able to wait longer to get the price you have been after. It takes away the urgency. But you could be better off if you sold your old property first even at a slightly lower price and avoided the cost of bridging finance.
You will need to do your own sums here because everyone has to take into account their different personal circumstances.
A bridging loan can be of great assistance if you wish to remain in your old home while waiting to have your new home constructed, even when the sale proceeds of your old home are needed to finance the building of your new home.