What is a bridging loan?


A bridging loan, or bridging finance, is a short term loan that finances the purchase of a new property while you are selling your existing property. Bridging loan can also provide finance to build a new home while you live in your current home. You will normally have 6 months to sell the existing property; or 12 months if a new property is being constructed.

How does a bridging loan work?

When you take out a bridging loan, the lender usually takes over the mortgage on your existing property as well as financing the purchase of the new property. The total amount borrowed is called the Peak Debt, and includes the balance of the loan on your existing home, the contract purchase price of the new home and any purchase costs such as stamp duty, legal fees and lenders fees.

The minimum repayments on a bridging loan will generally be calculated on an interest-only basis, and in many cases this interest may be capitalised until the existing home is sold – that is, accrued and added to the Peak Debt.

Once you sell your first property, the net proceeds of the sale (sale price minus any sale costs such as selling agent’s fees) are used to reduce the Peak Debt. The remaining debt then becomes the End Debt, which is repaid as a standard mortgage product from this point onward.

Bridging loan example scenario

The diagram below shows an example of the sale and purchase process in a bridging loan scenario.

Say the balance of the loan on your existing property is $200,000 and the funds required for the new property are $500,000. You may be able to borrow up to $700,000, which will be your Peak Debt. 

Bridging-loan-1


You now have a short term debt of $700,000, on which interest is payable, while you wait for the sale of your existing property.

If you’ve opted to capitalise the interest that accrues on the Peak Debt (assuming your lender offers this feature), the debt will continue to increase until you either start making repayments, or the sale of your existing property is completed.

To keep the numbers simple, let’s say in this example that you’ve been paying the interest and your Peak Debt remains at $700,000.

If the net proceeds of the sale of the existing property are $400,000 and you put that full amount towards the Peak Debt, then you will be left with an End Debt of $300,000 (that is $700,000 less $400,000).

Bridging-loan-2


From this point on, you’re just on a standard mortgage product with regular repayments.

Two key reasons to take out a bridging loan

1

Interest capitalisation

If your servicing capacity is not quite enough to cover the repayments on both properties, a bridging loan with an interest capitalisation feature may be a suitable solution, to allow you some financial breathing space while you wait for the sale of your existing property.

2

100% loan on the new property

A bridging loan can allow you to borrow up to 100% of the purchase price of your new property, plus the associated costs. This is particularly useful if you've purchased a property that is outside of your current borrowing capacity, but will become affordable once you've sold your existing property.

Capitalising repayments

When you capitalise the interest on a bridging loan, you are relieved of the necessity to make full loan repayments during the bridging period. Your Peak Debt will therefore be increasing each month as the interest is added to your loan. The interest charged monthly will be calculated on your Peak Debt, including the capitalised interest that has been added.

Wherever possible, making some repayments is recommended to stop the total amount of the loan ballooning and limit the amount of additional interest being charged.

Lending Assessment Policy of Bridging Loans

Below are some of the common criteria that lenders use to assess your bridging loan application.

Your home equity

When assessing the funds they will allow you to borrow, lenders will look at the equity in your existing home. The general rule of thumb is that the more equity you have, the more you’ll be able to borrow.

With or without End Debt

Most lenders offering bridging finance do so on the condition that there will be an End Debt. However, in cases where there will not be an End Debt, such as when you are downsizing your home, the fees associated with your loan may be higher.

Maximum End Debt

Where there is expected to be an End Debt, it’s important to note that this amount cannot be higher than the value of your new property. If you end up with an End Debt that’s over 80% of your new property’s value, you may be liable to pay Lender’s Mortgage Insurance (LMI).

Sale contract for existing property

Some lenders may require evidence that your existing property has actually been sold (i.e. a copy of the sale contract) as a pre-requisite for approval.

Existing loans

If bridging finance is required, usually the current lender is in the best position to assist. However if the existing lender does not offer bridging loans, a new lender will need to be used.

The new lender may insist on taking on the existing loan, which means paying out the existing lender. If this happens to be a fixed rate loan, early termination may result in break costs being payable by you for early termination of the loan.

 

What happens after the sale of your property?

Generally speaking, you would choose a home loan product for your End Debt before taking out a bridging loan, so after the sale of your existing property and the Peak Debt is paid down to an End Debt, you’ll simply be left with the home loan product of your choice.

How a mortgage broker can help with bridging finance

Depending on your circumstances, a bridging loan could be quite straight forward or somewhat complex. It’s worth discussing your needs with an experienced Mortgage Choice broker, who will research and compare different lenders, crunch the numbers, present you with options and then take care of all the paperwork and running around.

Get expert advice on your bridging loan

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