How bridging loans help Australians secure property in a competitive market
In our current competitive market, bridging loans can be a great idea for home buyers who buy a new home before selling their current one. Here’s why.
What is a bridging loan?
Sometimes called bridging finance, bridging loans are an ideal financial solution for buyers who find a new home before selling their current one.
Ideally, of course, you should use the sale price from your current home to purchase another one. But for many people, it doesn’t always end up this way.
Complicating the matter further is our current competitive property market, where properties are selling fast and prices are rising. In short: there’s often no time to waste on organising finance.
How bridging loans work
A bridging loan enables you to use the equity on your current home to secure your next property.
Generally speaking, your lender will combine the balance of your existing property’s mortgage with your new home’s purchase price, along with other costs, such as stamp duty, legal fees and similar.
This combination – or the total amount you’ll borrow – is called your “peak debt”, and means that until you sell your existing home, you’ll need to repay two loans simultaneously.
But your current property’s sale price will then fund these two loans, with the remaining balance becoming your “end debt”.
Moving forward, you’ll repay this one single loan as a standard home loan.
Interest capitalisation
If you’re struggling with the service capability for your next home, you may be able to utilise interest capitalisation with your bridging loan.
This means you won’t have to make regular repayments on this loan but instead, will repay it as a lump sum, including its accrued interest, when you sell your existing property.
NB: using interest capitalisation can be a tempting idea for its short-term cash relief; but your bridging loan will ultimately be higher.
Types of bridging loans
Closed bridging loans
Closed bridging loans have a fixed end date for repayment. So, they’re best for property owners who have a written settlement date for their existing home, or for those who’ve exchanged a sales contract with the buyer.
If you can’t sell your property within the agreed time frame, you risk penalty fees, higher rates, and even a forced sale by your lender.
Open bridging loans
With an open bridging loan, your final date to repay the loan isn’t fixed. They’re therefore a good idea for property owners who don’t have an exact sale date for their current home.
NB: you’ll still need to repay the loan within six to 12 months; otherwise, you’ll face the same fees and charges as closed bridging loan holders.
Pros and cons of buying before selling
Buying and selling property at any time will include benefits and risks, and the pressure to do so is definitely higher in our current seller’s market.
As I just pointed out, one of the big risks to bridging loans are potential, or unseen delays, in selling your current home.
The short-term nature of bridging loans also needs to be considered when taking out either of the two types of bridging loans.
Bridging loan advantages and risks
Advantages include:
- Purchase, and enjoy, dream home without waiting to organise finances
- Ability to buy faster in competitive market
- Extra time to prepare current home for sale
- No need to co-ordinate sale and purchase settlement dates
- Don’t have to move twice, shift to temporary rental situation, or use storage units
Risks include:
- Short-term loans (six to 12 months at best), regardless of open or closed type
- Above-average interest rates due to loans’ high-risk nature
- Interest-only loan means ultimate debt will be larger than standard one, especially if current home takes awhile to sell
- Possibility of extra fees or forced sale if existing home doesn’t sell within this time
- Current property might sell for less than expected, requiring extra funds to cover shortfall
- Pressure to accept unfavourable prices and settlement dates, due to above issues
How to minimise risks
If you’re concerned about the risks of bridging loans, there are ways to ensure you and your finances will survive this journey.
- Focus on your existing home’s sale
First and foremost, you need to settle the sale of your current property within your bridging loan’s short-term period; otherwise, you risk extra fees and charges.
- Have strong equity
Your equity is your deposit for your new home, so make sure it’s worthwhile. While all lender’s requirements are different on this score, you’ll generally need an equity of 20% or a Loan-to-Value Ratio (LVR) of 80% or less.
- Make regular loan repayments
I strongly advise all my clients to regularly repay their bridging loan, rather than repaying it in a lump sum. Your bridging loan rates will already be higher than your standard home loan and interest capitalisation will only mean a bigger debt in the end.
- Be conservative
Even in this competitive housing market, it’s best not to overestimate your current property’s sale price. Doing so can mean you end up with a much higher loan.
Also ensure you’re conservative with your funds in this buying and selling period as fees and charges can be higher than you initially planned.
How do I qualify for a bridging loan?
Lenders usually require the same details for a bridging loan, as they would for your current standard one.
Lender requirements
- Strong credit score, equity; high savings and little debt; reliable, stable income, and employment history
Documentation and valuations
- Recent rates, utility notices, cash flow, and financial statements for current property
- Current loan and mortgage agreements
- Punctual repayments on existing loan
- Existing home is on the market and you plan to sell within the bridging loan term
- Existing and new home’s sale values
- Required bridging loan amount (remember to include stamp duty, legal fees, moving costs and any renovations)
When is buying before selling the right move?
Consider market and personal finance conditions
Buying before selling is often considered a risky move and it certainly can be in a buyer’s market. But the opposite can be said for a good seller’s market, especially now in the lower-priced segments of our mid-sized capitals like Perth, Brisbane and Adelaide.
These cities are also low on property supply and buyer demand is high.
At the same time, market conditions are continuing to soften, while interest rate rises and the Middle East conflict have dampened buyer confidence.
All of these points are just as important for you to consider than the strength of your equity, credit score, savings and debt.
Seek professional advice from a mortgage broker
Never sign off on a bridging loan before speaking to an expert, such as a mortgage broker, about your situation. This is particularly important if you have been out of the market for a long time.
The team at Intuitive Finance can advise you on how much equity you need and what sale price to expect for your current house. They can also help you understand current market conditions and help you manage the move from old and new loans – and properties.
So, if you’ve got questions or concerns, just reach out to us.
Ready to move forward with confidence? Speak to a mortgage expert today and explore your bridging loan options.
