Most likely, everyone experienced this situation in their lifetime when they needed finance urgently to manage their home expenses. Say, you might be in the process of planning your new home, but your old property has not yet sold. This scenario can lead to a financial shortage during the purchase of that new home. Since people often use equity to fund their new homes, a financial shortage is a matter of concern.
But bridging home loans is one of the best solutions for this. It’s a short-term finance that allows buyers to fund their new property while selling their existing one. Since they are available for the short term, it’s also known as bridging finance. However, you may want to know about their working, pros, cons, and considerations before applying.
Bridging Home Loans Functionality
So, bridging loans are something homebuyers can take along with their existing home loans. As the name implies, they serve as a bridge between purchasing a new home and selling the old one. These are particularly useful in competitive real estate markets where timing is crucial.
These loans primarily use the borrower’s current home as collateral. This means the lender can seize the property in case the borrower is unable to repay the loan. Moreover, though this loan helps fund a new home, it combines existing debt over property too, that’s why it’s known as peak debt. Meanwhile, lenders typically allow 6–12 months to sell existing property and up to 12 months for new home construction.
But should buyers sell their property first or buy their new homes?
Sell an existing home or buy a new one first?
Well, their financial situation and the state of the market largely influence this decision. For example, if one gets the highest price for the property, they would likely sell their existing property before buying their new home.
While, given the affordable prices for a new home, they may opt to purchase it first. This is where bridging loans work best, where they first buy their new home before selling the existing one. But it has both pros and cons.
Pros and Cons of Bridging Loans
Although bridging home loans is a favorable option for raising funds in urgent circumstances, it has pros and cons.
Pros
- Flexibility: Bridging home loans allows buyers to fund their new home without waiting for their current property to sell. This approach offers high flexibility to plan their new home without affecting their existing state of loans or finances.
- Better Price on Existing Property: These loans may further allow borrowers to get a better price for their existing property if we are in a rising market. This is because homebuyers can wait for healthy market conditions alongside planning for their new home.
- Cash Flow Management: Many bridging loans also offer the option of making interest-only repayments during the loan term. As a result, homebuyers can easily manage their cash flow while waiting for the existing property to sell.
- Standard Fee Benefit: Moreover, these loans typically charge standard fees, similar to standard home loans. This makes them relatively straightforward to deal with in terms of costs and thus encourages more savings.
- Quick Access to Funds: Homebuyers, while using bridging loans, quickly access funds, enabling them to act fast to find their right properties.
Cons
- Higher Interest Rates: If your old home takes longer than usual to sell, the interest on a bridging loan will compound. As a result, it might increase the overall borrowing cost more than expected.
- No Redraw Facility: While bridging loans are a suitable option for quick financing, they do not offer a redraw facility. That means, for any reason, if you want to withdraw your money, you cannot do so.
- Risk of Overborrowing: If your current property sells for less than estimated, you may end up with a larger debt than planned. As a result, it will lead to increased financial stress and higher monthly repayments.
- Limited Time Frame: Usually, bridge loans are available for 6–12 months. So, if your old home doesn’t sell within this period, you may need to pay higher interest rates, or will end up selling the current property for lesser value.
- Strict Eligibility Criteria: Due to the short-term nature of these loans, strict eligibility criteria apply. For example, lenders usually demand higher equity to cover loan costs and stable income. So, not every borrower gets final approval for these loans.
Borrowing Limit of A Bridging Loans
Planning for a bridging loan also comes with a borrowing limit. Lenders usually calculate it as the total of your outstanding loan amount and the intended new property’s value. Say, if your debt is $5k and your new home is worth $10k, your peak debt is $15k.
Generally, lenders give the privilege of taking up to 80% of peak debt, and the remaining 20% is considered genuine savings. But that’s not the case all the time, many lenders still ask for substantial equity as collateral. So, homebuyers must be cautious about the borrowing limit.
Meanwhile, you will use the proceeds from the sale of your old property to repay your existing mortgage. Any money that is still owed will also be turned into a regular loan for your new house later.
Key Considerations While Planning for Bridging Loans
Along with the above, borrowers need to be cautious of the following things while applying for bridging loans:
Credit Score
When a borrower applies for bridging loans, lenders check credit scores as a primary step. So, the borrower must ensure they have not taken multiple approvals. This step is crucial because obtaining multiple approvals can significantly reduce your chances of receiving the loan. Furthermore, a borrower must ensure that they are regularly repaying their existing mortgage since it will imply responsible financial behavior.
Eligibility Requirements
Bridging loans follow strict eligibility criteria. So, borrowers must ensure they meet all of them. For example, they should have sufficient equity in their current homes. Meanwhile, they further need to ensure that they can repay their existing loan and the new bridging loan. Lenders also require proof of income to confirm stable income and savings and analyze borrowers’ capacity to make repayments during the bridging period.
Loan Amount and Terms
It’s not that the borrower can apply for a bridging loan for any amount, there’s a limit. For instance, borrowers can only raise 80% of their peak debt for a maximum of 6 to 12 months. This is because it depends on the timeframe of selling their existing property.
Risk Consideration
Although bridging loans charge the same interest as standard loans, they come with more risk. If the old property isn’t sold on time, lenders might impose higher interest rates on the remaining loan balance. Some lenders may even treat the loan under default condition, impacting the credit file negatively. These changes in turn may impact your cash flow or future plans.
So is a bridging loan the right choice for you?
When’s the Right Time to Consider Bridging Loans?
Generally, it would be a suitable option if you have already found your desired home. Meanwhile, you are also prepared to sell your old house since these loans often demand equity. So, that’s the right time for you to consider bridging loans.
However, with these loans, you’ll repay interest on both your existing mortgage and the loan for your new home simultaneously. Moreover, if you want to get rid of paying rent between buying and selling, then bridging loans will suit you. But you must be cautious about the market volatility since selling your old house depends largely on it. Thus, by confirming all these, you can go for a bridging loan with confidence.
Conclusion
Hence, for quick funding to buy a new home, bridging loans are no doubt a favorable choice. However, it comes with both pros and cons of having sufficient equity, high interest rates, flexibility, and cash flow management. Meanwhile, the borrowers should know the market conditions to get a better price for their existing home to repay loans.
For more information about bridging loans, speak to our experts at 1300 or 0456 456 267. Or contact us at Nfinity Financials.
FAQs
Here are some of the most frequently asked questions by our readers.
Q1. How long can you have a bridging loan?
These loans usually offer a 6-to-12-month term, allowing borrowers time to sell their current home after purchasing a new property.
Q2. How much can you borrow with a bridging loan?
You may borrow up to 80% of the peak debt (the sum of the existing loan and the new home’s value). However, this will depend on your circumstances regarding having sufficient equity in your current property.
Q3. What happens if you can’t sell my home within 12 months?
Failing to sell your existing property on time may result in higher interest rates being applied to your remaining loan or trigger default on the bridging loan. A lender may take possession of the current property and may even force a sale at current prices. You should discuss your options with your lender about extending your loan or refinancing, if possible, within the time frame.
Q4. How does a bridging loan affect your credit score?
Applying for a bridging loan involves a credit check, which can temporarily affect your score. Timely repayments and avoiding multiple loan approvals can improve your credit score over time.
Q5. Can you get pre-approval for a bridging loan?
Yes, just like standard home loans, you can obtain pre-approval for a bridging loan so you know how much you can borrow before starting your property search.
