Your search is at an end; you’ve found the perfect home and you’re already planning the kitchen renovations in your head. So it’s crucial to you that you buy the house as soon as possible, as you don’t want to risk someone else getting their hands on it!
There’s just one problem: You haven’t sold your current home yet or paid off the home loan attached to it, which will probably make it tricky to get approval for a new home loan.
In this case, you may be able to utilise a type of home loan known as a bridging loan (sometimes also known as bridging finance).
What is a bridging loan?
A bridging loan is a short-term home loan designed to help homeowners bridge the gap between buying their next home and selling their current property.
It involves a lender taking on your existing mortgage as well as providing you with a new short-term loan (the bridging loan) that covers the new property’s purchase price.
The total amount of debt taken on by the lender (between your existing mortgage and the new loan’s total amount) is referred to as your ‘peak debt’ and includes any costs of purchasing the new home, such as stamp duty and any legal or lenders’ fees.
How does a bridging loan work?
Once your current property is sold, the proceeds (after fees) will be used to pay down the peak debt, and the remaining amount will then typically be converted to a standard home loan product.
The new component of a bridging loan will usually only require interest-only repayments, meaning you won’t be required to pay down the new principal (the amount you borrowed) while it’s still at the bridging stage. Additionally, you can also opt to capitalise your interest costs into the loan, meaning they’re added to the total loan amount rather than charged as regular repayments.
However, keep in mind that you’ll be required to continue making your regular home loan repayments towards your existing home loan principal, the ‘old’ component of your bridging loan.
Types of bridging loans
You’ll generally have a choice of two different types of bridging loan, and your choice will typically be determined by how much progress you’ve made in buying your new home. Let’s go over how the two types of bridging loan work and explore what kinds of borrowers and financial situations they might be suitable for.
Open bridging loans
Open bridging loans are designed for prospective homebuyers who are still just that – prospective. An open bridging loan will probably be the right choice for you if you don’t have an agreed settlement date for your existing property just yet, as their longer life (usually up to 12 months) makes them suitable for those who are still looking around.
While this open-ended flexibility can be invaluable in helping you navigate both the buying and selling processes with minimal hassle, keep in mind you’ll be accruing interest charges for however long it takes you to sell your current home. If it takes you the full 12 months to sell your home, you may find yourself saddled with significant interest charges as a result.
Closed bridging loans
If you’ve got a contract of sale in place and know when settlement date will be, you could opt for a closed bridging loan. This type of bridging loan is for those working within a specified timeframe, who know exactly when their existing home is going to be sold.
At the end of the loan’s timeframe (usually settlement day), you’ll pay down your peak debt as well as any interest and fees accrued during the bridging loan term.
Who’s eligible for a bridging loan?
To qualify for a bridging loan, you’ll typically want to have satisfied the following requirements:
- You meet your lender’s standard lending criteria for home loans
- Your current home is listed and available for sale on the market
- You have at least 20% of the bridging loan’s peak debt in either savings or existing equity in your current home and will end up with a maximum loan-to-value ratio (LVR) of no more than 80%
- Your current home has been professionally evaluated and you have a formal property valuation you can show your
Please keep in mind that your lender may have additional eligibility requirements for bridging loan applicants; you may want to speak with your lender before submitting a formal application.
What are some bridging loan pros and cons?
As you can see, bridging loans come with a very specific set of upsides and downsides. Let’s put the main points side by side to see how they stack up.
|Offers you the flexibility of buying a new home before you’ve sold your old one.||Taking on such a large amount of debt could be stressful, particularly if you’ve opted for an open bridging loan.|
This can also hold true for closed bridging loans, especially if there’s a lengthy settlement period involved.
|The ‘new’ component will typically be interest-only, and you can usually opt to have that interest capitalised into the loan to reduce your immediate costs.||Opting to capitalise the interest into your loan can leave you with a much bigger home loan balance than you were bargaining on.|
|Can help you avoid renting and storage costs.||Your home may sell for less than you want due to the property’s value declining, or it may not sell at all – in this case, you’d most likely find yourself under severe financial stress.|