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Key takeaways:
- A bridging loan allows you to use the equity in your current property to finance the purchase of a new property.
- Interest rates are usually higher on bridging loans compared to standard mortgages.
- Bridging loans are only designed to last about 6-12 months but can be a convenient form of short-term finance.
What is a bridging loan and how does it work?
A bridging loan is a temporary home loan meant to assist borrowers in buying a new home while they wait for their existing property to sell. It bridges the financial gap between purchasing the new property and selling the current one, while also removing the inconvenience and cost of renting in the meantime.
Bridging loans are usually meant to last 6-12 months at most. During this time, they often come with higher interest rates compared to regular home loans. If you take out a bridging loan, the amount borrowed is added to your existing mortgage, leading to higher repayments throughout the bridging period.
In a nutshell, you’ll have two loans to manage, along with any additional costs like stamp duty. These loans combined and the associated costs are known as your ‘peak debt’.
Fact: There are two types of bridging finance - ‘closed’ and ‘open’. A closed bridging loan has to be repaid by a specific date, while an open bridging loan normally has a term of 6-12 months without having a predetermined settlement date.
Why do borrowers get bridging loans?
A bridging loan offers funds to bridge the gap between selling your current home and buying a new one, without needing to line up settlement dates. It enables borrowers to buy a new property or start building a new home while still living in their current one.
This short-term finance can be useful in competitive real estate markets, allowing buyers to secure a property quickly without the condition of selling their current home first.
Bridging loan example
Meet Sarah, a homeowner whose property is valued at $800,000, with an outstanding loan amount of $400,000, giving her $240,000 in usable equity. Sarah discovers a property she loves priced at $1 million but needs time to prepare her current home for sale and wants to secure the new property quickly to avoid missing out.
With $240,000 in usable equity, Sarah decides to take out a bridging loan. Her existing $400,000 home loan is converted into a bridging loan for a fixed 12-month period. Additionally, she is approved for a $760,000 home loan for the new property.
This results in a total home loan balance of $1 million: a $240,000 bridging loan and a $760,000 ongoing home loan. During the bridging period, Sarah has the flexibility to make interest-only repayments to manage her finances effectively.
Sarah sells her current home with the proceeds being used to repay the bridging loan well within the 12-month period, and without penalty. She then continues making repayments on the $760,000 ongoing home loan for her newly purchased property.
Sarah’s case demonstrates how bridging finance can assist homeowners like her in navigating the transition between properties while leveraging equity and securing a new home without waiting for the sale of her existing property.
Are bridging loan interest rates high?
The short answer is yes, particularly when compared to standard home loan interest rates. At the time of publication, a good interest rate in Australia is around 6% p.a., while bridging loan rates sit anywhere from 6.50% p.a. to 10% p.a. The actual bridging finance rate you get will depend on your personal circumstances, your loan-to-value ratio (LVR) and credit history.
Although most banks and lenders charge higher interest rates on bridging loans, there are some providers that offer the same or similar rates as standard home loans. Most mortgage brokers will be across which lenders offer competitive rates.
Bridging loan pros and cons
Pros
- A convenient option to secure a new property without needing to sell your existing home
- Usually come with flexible repayment options during the bridging period where you have ‘peak debt’, including interest-only payments
- Purchase costs of the new property like stamp duty and legal fees can be incorporated into the bridging loan
- If you sell your existing home sooner, there is normally flexibility to pay off the loan earlier without penalty
- It means you don’t have to find a place to live in the meantime, reducing stress and costs in finding a rental
Cons
- Interest is calculated daily and charged monthly, meaning the longer it takes to sell your current property, the more interest you’ll pay
- You must manage repayments for both the bridging loan and the existing mortgage simultaneously until the old property is sold, potentially straining cash flow
- If the sale of your existing home takes longer than expected or sells at a lower price, you may face challenges in repaying the bridging loan, leading to additional costs or needing to refinance
- Some lenders may require a valuation for both properties, adding more expenses than you might have budgeted for
- In most cases, interest rates will be higher than standard home loans
Tip: You'll need an exit strategy. How do you plan to repay the bridgng loan? Do you have a confirmed sale on your existing property, anticipated funds from another source, or a clear timeline for refinancing? A solid exit strategy is essential for managing risk.
Eligibility for a bridging loan
Here are the key requirements lenders consider when assessing eligibility for bridging finance:
- Australian citizenship or permanent residency
- You must be over 18 years of age
- You need to demonstrate your ability to make interest-only repayments on your peak debt (your existing mortgage and the bridging loan)
- Some lenders may require you to have savings that covers the amount of interest you’ll pay during the bridging period
- This type of finance typically only lasts up to 12 months, so you need to be confident in selling your current property within this period (some lenders won’t approve bridging finance for properties in rural areas for this reason)
- You’ll need a high level of equity in your current property, or a loan-to-value ratio (LVR) of at least 80%
How to apply for a bridging loan in 10 easy steps
Here’s how a bridging loan generally works under the helpful guidance of a mortgage broker. Keep in mind that the exact process may be different based on the broker you work with and the type of bridging finance you choose.
1
Initial consultation
Meet with a mortgage broker to discuss your financial situation, goals, the details of your existing property and the new property you wish to purchase.
2
Financial assessment
The broker assesses your eligibility for a bridging loan based on your income, existing mortgage, equity in your current property and the potential sale value of your current home according to market conditions.
3
Loan application
Provide your broker with documents such as proof of income, details of your current mortgage and information about the properties involved.
4
Pre-approval
If eligible, your broker will help you obtain pre-approval for the bridging loan. This allows you to confidently make offers on new properties you want to buy.
5
Make an offer
With pre-approval sorted, you search for a new property and make a formal offer.
6
Loan submission
After finding a new property, the broker submits your loan application for the bridging loan to the lender. The lender evaluates the application, considering both properties and your financial circumstances.
7
Settlement
If the loan is approved, the bridging loan funds can be used to purchase the new property. At this stage, you are holding two loans: the bridging loan for the new property and your existing mortgage for the current property (peak debt).
8
Sale of current property
You place your existing property on the market and sell. Once sold, the proceeds are used to repay the bridging loan, including any additional costs.
9
Transition to new mortgage
After selling your current property and repaying the bridging loan, you move to a standard mortgage for the new property. Your new mortgage is referred to as your ‘end debt’.
10
Completion
You now start making repayments on your new mortgage while receiving ongoing support from your mortgage broker.
Bridging loan alternatives
If you lack confidence in a quick sale of your existing home or you believe you’ll struggle financially during the bridging period, then it may not be your best option. Thankfully, there are some other alternatives to bridging loans.
Deposit bond: This is a product offered by insurance companies and some lenders to pay for a deposit to secure a new property. It is essentially a guarantee to the seller of the new property that the deposit will be paid by the due date.
Keep in mind that a deposit bond only covers the initial deposit and that the remaining balance of the new property will require funding. Deposit bonds are typically used when you’ve agreed to sell your current home and are awaiting the sale funds, but have already found a new property to purchase in the meantime.
Extend the settlement period on your new home: Rather than accept a settlement period of 30 days, ask for a 90-day settlement instead. This will give you more time to sell your current property before the sale of your new home takes place.
While negotiating a longer settlement period can be helpful, there are no guarantees that your existing property will settle during the extended 90-day period. This can be particularly true when market conditions are slow or your property is located in a rural area.
Alternatively, you can ask your solicitor to negotiate a condition in the contract of the new home that it’s subject to selling your current property. However, not all sellers will agree to this, especially in a competitive real estate market.
Sell your current home first: You could wait to sell your current property before applying for a new mortgage. However, this means you might need to rent temporarily (or stay with relatives or friends) between selling your old home and finding a new one.
If you’re downsizing, you may have room in your budget to cover renting for a short period. Otherwise, you risk depleting your savings and facing potential property price increases during the interim.