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Bridging Loans: How Do They Work?

20th Aug, 2020 | Loan Features, Refinance

In this article:
Should you buy or sell first? Understanding how a bridging loan works can help you decide which option to take when moving homes.

The purpose of a bridging loan is to provide you with a short-term financing option for transitioning between the purchase of a new home and the sale of your existing one. To understand how this type of loan works, it helps to think of it as an interest-only loan with a specific term. 

Your total payments during this specific period will depend on the lender and the structure of the loan. Some bridging loans require you to continue paying off your regular loan as you always have, while at the same time paying interest on the bridging loan. But with other bridging loan structures, the interest is added to the loan, so you’re not expected to start paying it off until you sell your existing home. Either way, because the interest compounds monthly, the longer it takes to sell your property or start paying interest, the more interest will accrue. 

Bridging loans aren’t automatically available to all borrowers. While different lenders have different assessment criteria, many will look at the equity in your existing home before deciding on your creditworthiness and borrowing power. They will also need you to meet their serviceability measures, which include evidence of your income, expenses and other commitments. 

It’s less difficult to get a bridging loan if you are in the process of selling your home. Apply for a ‘closed bridging loan’ if you have already exchanged contracts and your settlement day is fixed.

How are bridging loans calculated?

The Peak Debt is used to calculate how much interest you owe in the time leading up to the sale of your existing home.

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Take the balance of the loan on your existing home and add the funds you require for a new property. Tally up transaction costs like stamp duty and legal fees and add this on. The total cost is referred to as the Peak Debt.
 
The Peak Debt is used to calculate how much interest you owe in the time leading up to the sale of your existing home. The interest rate offered will depend on your circumstance and the level of financial risk you represent.
 
Once you sell your existing property, the funds that remain after having paid off all the sales costs (real estate fees, conveyancing, etc.) come off the Peak Debt. The amount left is known as the End Debt, and this is the amount you pay off from then on out.
 
As part of this process, you will need to pay for the valuation of your existing property and the valuation of your new property.
 
Are bridging loans a good idea?
 
Bridging loans give you the flexibility of buying a home quickly without the complication of having to sell your home first. However, be aware of the following risks:
  • Your property sells for less than you anticipated
If you overestimate the sales price and end up selling for less, you may struggle to pay off your loan. When deciding on the likely sales price, do your research of other similar properties in the area and have realistic expectations.
  • Your property takes ages to sell
Bridging loan terms are typically for six months if you’re selling an existing property, or 12 months if you’re constructing a new home. The longer the sale takes, the more interest you will pay. Your lender may increase the interest rate or step in to assist with selling the property if it remains unsold beyond the agreed period. A good backup plan is to make as many repayments as you can during the bridging stage to help reduce your total debt.  
 
Bridging loans can be complex to understand, so be sure to seek additional advice from your Yellow Brick Road mortgage broker. There are so many moving parts depending on your unique situation, including whether you have a deposit saved and whether you need Lenders Mortgage Insurance. Give us a call, and we’ll go over the details with you.