In this article, we’ll cover everything you need to know about bridging loans – what they are, how they work, when you might consider one, the benefits of using them and common eligibility criteria.
What is a short-term bridging loan?
Increasingly popular in Australia, and available from a variety of lenders, short-term bridging loans help you ‘bridge the gap’ between buying a new home and selling your current home. There are other circumstances where you might consider a short-term bridging loan which we’ll cover later.
Short-term in nature, these loans are typically for six to 12 months’ duration, and usually range from $25,000 to $500,000, depending on the lender and your circumstances. In Australia, you can often apply online for a bridging loan. Private lenders, in particular, are known for offering a simple application process, minimal documentation and fast funding (usually within three to five days after applying).
How does a bridging loan work?
The best way to explain how short-term bridging loans work is to use an example.
Say you own a property worth $800,000, with an existing mortgage of $400,000. In this case, you have 50% equity that you can use to go toward purchasing a new home. You find your new home, and it is going to cost $1 million. But you are yet to even list your current home for sale.
To avoid a potentially costly rushed sale of your current home, you take out a bridging loan to buy the new home, adding $1 million to your current loan balance. So, you now have total borrowings of $1.4 million. You then put your current home on the market, sell it in say three months for $800,000, and pay down the combined loan, leaving an ongoing balance or ‘end debt’ of $600,000.
For simplicity, we haven’t mentioned purchase or selling costs in this example. Generally, you need to allow around 5% to cover purchase costs, such as stamp duty, and 2-3% to cover selling costs, such as agent fees.
Features of a bridging loan
In the above example, for three months you have a combined loan debt of $1.4 million. While this might seem daunting, one of the key features of a short-term bridging loan is that during the bridging term the additional loan amount is interest-only.
Furthermore, many lenders will allow the interest to be capitalised, meaning it gets added to the loan, to be repaid at the end of the loan, when your current home is sold. This helps to avoid financial stress on the combined loan balance. In other words, during the bridging term, you continue to pay the principal and interest on your initial mortgage (in this case $400,000). The bridging loan interest on the additional $1 million is then paid with the proceeds from the sale of your current home.
When you do the numbers, you’ll find the cost of a short-term bridging loan can be favourable compared to the costs of renting if you sell before you buy, storage costs, or the costs of moving home twice. Not to mention avoiding the stress of all that!
Of course, if you have the capacity to pay more during the bridging term.
When might you consider a short-term bridging loan?
The most obvious use of a short-term bridging loan is to help to manage the sometimes tricky juggling act of purchasing a new home before your current home is sold. In this case, it’s all about the timing and if you don’t get it right, you might miss out on purchasing your dream home, or be forced to rush the sale of your current home.
Beyond this scenario, there are other uses of bridging finance that can help you get access to funds for a short period of time prior to selling a property. These include:
• Funding renovations to prepare your property for sale
• Completing a small land subdivision or duplex that will be sold on completion
• Securing a deposit for a new property (principal place of residence or investment property)
• Assistance with costs such as moving, medical, legal or living expenses
• Payment of a personal bill or debt (such as a tax debt) that needs to occur immediately
• Downsizing your home
Common to all these scenarios is a pending property sale that will allow you to discharge some or all of the total borrowed funds within a relatively short timeframe.
The main benefits of a short-term bridging loan
Short-term bridging loan have several benefits including:
• Buy now and sell later: You don’t have to watch your dream home pass you by while you try to sell your current home.
• Unrushed sale of your current home: With a bit of breathing space, you’ll avoid the potential loss that can occur with a rushed or forced sale of your current home.
• Don’t move twice: Renting a home (and maybe storage space) after you sell a home and before you buy a new home, and moving twice, is costly and stressful.
• Capitalised interest payments: Many lenders allow interest to be capitalised and paid once your home is sold (meaning you don’t make payments throughout the loan period).
• Standard interest rates: Some lenders charge higher interest for bridging loans, but the good news is there are many lenders who charge standard variable interest rates on this type of loan.
• Make additional payments: If you have the capacity to pay principal and interest on the combined loan during the bridging period, you can reduce interest costs.
What type of bridging loans are available?
There are effectively two types of bridging loans, determined by the status of the sale of your current home:
• Closed bridging loan: This loan type is ideal for when you have exchanged contracts at an agreed price and agreed settlement date. This loan structure provides more certainty for the lender and is considered less risky as exchanged property sales rarely fail to settle.
• Open bridging loan: This type of loan is needed if you have found your new home, but are yet to put your existing home on the market. This is a riskier proposition for both you and the lender, so be prepared to answer more questions.
How do you qualify for a bridging loan?
As is always the case when it comes to property loans, the equity you have in your current home is the key factor in your eligibility for a short-term bridging loan, as well as the amount you can borrow. As a general rule of thumb, lenders will be looking for at least 50% equity in your current home to qualify for a bridging loan.
There are many lenders to choose from, given the increased popularity of short-term bridging loans. Besides the traditional big banks, a growing number of non-bank lenders, private lenders and fintechs offer bridging loans. In Australia, you can apply online for a short-term bridging loan from a range of lenders.
While interest for the bridging period can be capitalised, your capacity to repay the ‘end debt’ or ongoing mortgage will also be taken into consideration.
Buying a new home and selling your current home can be very stressful. Acquiring a short-term bridging loan is one way to reduce stress whilst allowing you to secure your new home, before you sell your current home. We’re spoilt for choice, with many lenders all offering short-term bridging loans for a variety of purposes.