Bridging loans: what are they used for?

A bridging loan (also known as bridging finance) is a short-term loan that helps you to finance your next purchase while you wait for your current property to sell.

Many people use their equity to fund their next home purchase by selling their current home. However, the homes may not be sold simultaneously. Instead, they might buy first. Bridging loans provide a solution to this problem. Bridging loans are also used by people living in their existing homes while building their new homes.

In the loan process, you receive a line of credit from the bank that covers what you will contribute to the next property. The funds raised to pay off your existing home loan and your bridge loan will be used to pay off your current property when it sells.

Examples of bridging loans

Here’s an example. Ryan and Mia own an apartment with a mortgage of $400,000 owing and have $200,000 worth of equity. They find a new family home they want to buy for $900,000 and want to use their $200,000 worth of equity to put towards the purchase. Unfortunately, they haven’t yet sold their apartment and the auction for the new home is this weekend.

If Ryan and Mia decide to utilise bridging finance, they will have a loan of $400,000 on their apartment, a bridging loan of $200,000 and a loan of $700,000 on their new home bringing their total debt to $1,300,000. Once their old property is sold, the $400,000 apartment mortgage and $200,000 bridging loan will be repaid, leaving them with a single loan of $700,000.

Things get a bit complex here. Bridging loans are hindered by the fact that banks place significant buffers just in case the home doesn’t sell for enough. Many banks will value your current home and subtract 15% from its value before determining whether you have enough equity. As soon as the buffer is added to the capitalised interest, purchase costs, and sale costs, obtaining a bridging loan becomes difficult.

The value of Ryan and Mia’s property would need to be around $800K for a $200K bridging loan to qualify.

When can a bridging loan help you?

You can use a bridging loan if you’ve found the house of your dreams but can’t use your equity to buy it. You still need to have a deposit available. A redraw facility lets you access funds you have saved or accessed via a redraw facility.

The ‘bridge’ must be paid off within 12 months after you sell your home.

When is a bridging loan not suitable?

Not everyone is a suitable candidate for a bridging loan. Bridging loans usually charge higher interest than traditional home loans. Therefore, this type of financing will cost you more.

You will be paying two mortgages at once if you decide to buy before you sell. One for your old house and one for your new house. None of these costs are covered by a bridging loan. You can use the equity from your previous home when you sell it. The bridging finance has a higher interest rate (around 5.5% at the time of writing) and you are effectively paying the cost of two mortgages.

Selling your current home might be forced by a bridging loan. The bridging loan has a 12-month repayment period once you obtain the loan.

Finally, consider if your current property sells for less than you expected. Your sale proceeds may not be enough to repay the bridge loan. This doesn’t happen often because banks have a protective buffer. As you can see there are many factors to think about before applying for a bridging loan.

Have you thought about bridging loans but aren’t sure? Get in touch with us!

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