After months of back and forth in searching for your perfect home, you finally found it. However, you don’t have enough funds at the moment to cover the costs, and your current house is still up for sale; there’s a dilemma happening here, and you’re in a time crunch since you have competitors who also want to purchase your home.
In an ideal world, we’d have the privilege of being able to keep the dates of selling our old homes and buying new residential properties synchronised, but unfortunately, the world doesn’t work that way.
A bridging loan is helpful for situations like this, and many homeowners take this route when moving from one home to another. But how exactly can this loan help you?
In this article, we’ll guide you through exactly what a bridging loan exactly is.
What is a Bridging Loan?
A bridging loan allows homeowners to purchase a new home before selling their current one without making more payments on the overall home loan.
Being able to sell off a property takes longer than expected, and if you’re planning on using the funds coming from the sale to be able to purchase the new property, then there’s a lot more pressure involved.
Because of this, the bridging loan was implemented to cover the period in between by providing you additional funds to be able to buy a new property while selling your current one.
For example, you’re living in your current property, and suddenly, after browsing through listings, you see the house of your dreams. You may already have the deposit for the home you want to purchase, but you haven’t sold your existing house yet. Additionally, your income may not be sufficient to cover the costs you’ll need to pay.
With bridging loans, you can have your existing home while being able to purchase your dream home at the same time. Hence the term “bridging” because the loan acts as the bridge for the homeowner to be able to cross the financial gap of selling their current home and buying their next residential property.
Types of Bridging Loan
Two types of bridging loans are available in Australia: open bridging and closed bridging. Depending on your circumstance, one type of bridging loan would work better than the other. To figure out which type of bridging loan would tailor to your situation, it’s best to consult a financial specialist. In the meantime, you can learn the difference between the two here.
Open bridging loan
An open bridging loan is generally used when the final date for the loan repayment is not known in advance, which means this type of loan is available for borrowers who haven’t sold their current house yet, and no settlement date has been agreed upon yet.
The most common scenario of bridging loans is when the homeowner is either upgrading or downgrading their current property that hasn’t been sold yet.
Closed bridging loan
A closed bridging loan is more suitable for borrowers with an agreed date on when the property will sell. If the homeowner already has a Contract of Sale on their current residential property and has an idea when the date the house is to be sold and when the funds will be received, then the closed bridging loan is much more suitable than the open bridging loan.
How Do Bridging Loans Work?
Bridging loans are short-term loans that can offer up to 12 months (or a year) to be able to cover the costs of the financial gap between buying a new residential property and receiving the profit earned from selling the current one.
The size of the bridging loan will depend on the amount of debt that your current residential property has, as well as the cost of purchase of the new house. Combining these two values, you get what’s called your ‘peak debt’.
As soon as you can sell your house, the (net) earnings of the sale are utilized to decrease the peak debt. The debt remaining is now referred to as the “end debt”, which is then reimbursed typically as a mortgage product later on.
How to Qualify for a Bridging Loan
Do you want to apply for a bridging loan but don’t know if you’re qualified to receive one? While a bridging loan seems like a foolproof way to secure your future home while your current property is still on the market, not everyone can apply for this loan.
Luckily, the requirements to be able to get approval for this loan aren’t as plentiful as compared to different kinds of loans.
To be able to qualify for a bridging loan, lenders will need to take a closer look at your income status, equity, and the state of your current property. Keep reading for more detailed information about the different requirements.
Your serviceability
Like any other loan, you must pass the general serviceability conditions. This includes proof of your income, employment status, and other necessary documents that provide information that you are deemed fit to receive the loan.
Your equity
While there is no written rule about the amount of equity needed, lenders will typically approve homeowners with more than 50% in equity for the bridging loan to be worth it. And that’s because the equity you have in your current residential property is an important factor in determining your eligibility for obtaining the loan.
Your current property must be on the market
Of course, you can’t have a bridging loan if you don’t have any current house for sale on the market.
Benefits of a Bridging Loan
Are you still deciding whether or not to apply for a bridging loan? Here are a few of the many advantages of getting this type of funding.
It’s fast and convenient
Bridging loans allow you to purchase your new residential property immediately without requiring long waiting times and added stress. It makes buying a new home more exciting and less troublesome. With this, you don’t need to sell your old property hastily and can even get a better value for your current house.
Avoid renting
Having a bridging loan saves you the trouble of renting. Typically, you would have to deal with selling your current house first, then temporarily moving into a place where you may have to rent for a bit and then moving again as soon as you find your new place. With the loan, you no longer have to move to a temporary rental property and just proceed straight to your dream home, saving you from unnecessary costs in moving in the long run.
Repayment
This will depend on how your bridging loan is structured–what terms have been agreed on. But, during the bridging period, you may only be required to make repayments based on your existing mortgage.
Other Things to Consider When Getting a Bridging Loan
Now that you know the different qualifications when getting a bridging loan, as well as the benefits that come along with it, there are a few more vital pieces of information that you must learn about. Here are some other things you should consider when getting a bridging loan.
The bridging loan is not for everyone
As mentioned previously, bridging loans are not meant for anyone. Typically, lenders would ask for a specific amount of equity in one’s current residential property so that the borrower can give out a considerable deposit on their new house for them to get a lower loan-to-value ratio.
Take note of the compounding interest
If you know how compounding interest works, it would most likely double in this scenario because you’ll have two loans. Compound interest is simply when the interest is added to the initial amount invested or borrowed. The longer it would take for the old house to be sold, the more interest would accrue, and you would have to pay more for the loans. The interest is calculated daily and possibly charged monthly; therefore, this could all pile up pretty fast, depending on how much you’ve borrowed.
Make sure you understand the conditions of the loan
This sounds straightforward and obvious, but many still forget to read the fine print and do not know how the loan works. Read every single detail and ask for clarification if there’s something that you don’t understand. Do that carefully before signing the agreement. The last thing you want is to sign a contract with terms that you don’t 100% agree on.
Risks of Getting a Bridging Loan
Getting a bridging loan as a homeowner is definitely going to take a lot of weight off of your shoulders, but do keep in mind that there are also risks that you need to prepare for before you pursue the loan. Here are some of them:
You have to pay for two valuations
The valuations are for both your current property and your new home. The valuation is essential to push through with the bridging process. Generally, the valuation cost can range from $200 to $220.
There is no redraw facility
It will not be allowed if you decide to make repayments during the bridging period but have to redraw, regardless of the reason.
Higher interest rates for properties not sold in time
If you’re unable to sell your current residential property within the ‘bridging period’, then you’re most likely going to incur a higher interest rate, and lenders will charge you for that. A lot will also instruct you to make principal and interest repayments on the peak debt to be able to make do with both loans. This can cause overwhelming financial stress for a regular person.
How to Determine if Bridging Loan is Right For You
Here are some tips or key considerations to remember to help you determine whether or not a bridging loan is suitable for your situation:
- You must have at least 50% of your equity in your current house.
- Experts recommend making payments throughout the bridging period to be able to keep the interest rate and overall debt at a minimum.
- Assess your current residential property and set realistic expectations about the price you want your house to be sold for.
- Be practical about the overall timeframe of how long it’ll take for your existing property to be sold. Ask yourself questions about the real estate market at your location and how long it would take to reach a settlement.
- Do you have a backup plan? What do you plan to do if your current property isn’t sold as quickly as you thought? Perhaps you’ve already planned to move back home or stay someplace rent-free temporarily?
These are just a few of the many necessary factors you need to consider before applying for a bridging loan. If you are 100% sure you won’t run into any problems or at least have a solution for them, then you can confidently conclude that a bridging loan will help you a lot in the long run.
It’s still best to consult with a reliable mortgage broker or property investment specialist so that you have someone to guide you throughout your journey.
Final Takeaway
Applying for a bridging loan is a perfect solution for homeowners who have their eyes on a new property and want to sell their current house. Here at Zanda Wealth, we want you to have your hands on your dream property minus the fuss! Be in touch with some of the best mortgage brokers in Australia and reach your property investment goals faster!
You’re in good hands with us. Get started with a free strategy session today!
