In a perfect world, selling your property and purchasing a new one happens at the same time. But unfortunately, there’s no such thing as perfect, and sometimes once you’ve found the new property of your dreams, it may take you a while to sell your current one. This may mean you cannot access the finance you need to actually secure the property you’re buying.
Enter bridging loans.
What are bridging loans?
If you choose to purchase a new property prior to selling your current one, bridging loans help cover you for the time you have both home loans. Some people refer to this as bridging finance. However phrased, it’s a short-term loan which helps finance the purchase of an asset. In other words, it’s an interim loan to help fill the gap between purchases and sales.
A bridging loan allows you to settle on a new purchase, even if your sale isn’t yet completed.
Like normal loans, bridging loans offer either fixed or variable rates, and an interest-only repayment feature. The main differences tend to be the length of the loan, usually being between six and 12 months, and the interest rate.
To work out the loan amount, lenders will add the value of the new property to your existing mortgage. They’ll then subtract the likely sale price of your existing property. Lenders will then assess whether you’re able to make repayments on this ongoing balance.
There are two types of bridging loans:
1. Closed bridging loan: a date for sale of the property is agreed, and when it is settled the principal of the bridging loan will be paid. This is only available to those who have exchanged on the existing property, but are yet to settle.
2. Open bridging loan: this is for people who do not have a sale date for their existing property on the market, and therefore there is no end-date. This is considered much riskier for lenders, and will likely incur many more questions.
Importantly, many lenders will not agree to a bridging loan if you are likely to sell the property in less than three months.
Generally, interest rates for bridging loans are slightly higher than normal rates. This is because there is a higher risk to the lender. It is also because the timing of the loan is short term.
The interest rate, as with other loans, will depend on your situation and the risks involved. Of course, often risk is in the eye of the lender, so it’s worth speaking to a few, as some are now treating bridging loans like any other and will match the interest rate.
Another thing to remember when it comes to rates is whether you’ll need Lender’s Mortgage Insurance. Generally speaking, if you are borrowing less than 80 per cent of the combined value of the properties (the purchase price of the new property and the amount currently on your mortgage), you won’t have to. Anything more, and you’ll be forking out more money.
Pros and cons
There are several advantages and disadvantages to using a bridging loan.
- You can purchase a new property without having to wait for your old one to sell.
- Gives you more time to hopefully get a better price on your existing property.
- You only ever have to manage one loan.
- There are no higher fees than a standard loan. Also, you don’t have to worry about breakage fees or discharge fees for paying off the loan quickly.
- Helps you avoid the costs of moving twice and renting.
- Interest is compounded on a monthly basis, so the longer it takes to sell your property, the more interest you will accrue and pay.
- You’ll need to pay for two valuations – one on your existing property, and one on your new purchase.
- Interest rate rises if you don’t sell your property in time. Many lenders will start to charge higher interest rates if your property is not sold within the bridging loan timeframe. Some will also require you to start paying principal and interest repayments.
- If your current lender does not offer bridging loans and you need to go to another one, it’s likely the new lender will insist on taking your entire debt. This means you’ll be liable for early termination fees and break costs of your existing loan.
Here are some final tips to consider when deciding whether to take out a bridging loan:
- Don’t overestimate the sale price of your existing property. This means you may fall short when it comes to paying back the bridging loan.
- Try to have at least 50 per cent equity in your existing property. This way you will avoid having a pay a large interest bill.
- Be realistic with the time it will take to actually sell your property, and remember to include the time it will take to settle.
- Remember to budget for all other expenses including inspections, stamp duty, valuations, repairs, and bank and legal fees.
- Always shop around and do your research.