Bridging Loans: How They Work, Benefits, and Choosing the Right One

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Buying a new home before selling your current one can feel like a juggling act. How do you secure your next property without the money from the sale of your existing one? This is where bridging loans come in. A bridging loan is a short-term loan that helps you finance your new home while you wait for your current property to sell.

We’ll explore how bridging loans work, their pros and cons, and how to choose the right one for your situation. Whether upgrading, downsizing, or relocating, a bridging loan can simplify and stress-free your move.

What is a Bridging Loan?

A bridging loan is a short-term loan designed to help you buy your next home before selling your current one. It “bridges” the financial gap, giving you the funds needed to secure your new property while waiting for your old one to sell. This way, you can avoid couch-surfing at your in-laws or paying for temporary accommodation.

Types of Bridging Loans

There are two main types of bridging loans you can choose from:

• Closed Bridging Loan: This type of loan is ideal if you’ve already sold your current property and are waiting for the sale. Because you have a fixed repayment date, usually based on the settlement of your existing home, lenders see this as less risky. The repayment date can vary, but it often takes 30 days or more, depending on the contract with your buyer. As a result, you’ll often get more favourable terms, like lower interest rates.
• Open Bridging Loan: If your current home is still on the market or you haven’t secured a buyer yet, an open bridging loan offers more flexibility. With no fixed repayment date, this loan gives you 6-12 months to sell your property. However, since there’s more uncertainty for the lender, open bridging loans usually come with higher interest rates and fees. It’s perfect if you’ve already got your eye on a new place but haven’t had luck selling the old one yet.

Pro tip: A qualified mortgage broker can help assess your personal circumstances and recommend the best bridging loan for your needs. If you don’t have one, look at our shortlists of the best mortgage brokers in Sydney, Melbourne and Brisbane.

How Does a Bridging Loan Work?

Here’s how the typical process of obtaining and repaying a bridging loan works:

1. Application: You start with an application, usually through a mortgage broker or directly with a lender. You’ll provide details about your current and new properties, your financial situation, and the expected price of your next home.
2. Funding: Once approved, the lender sends you the money to buy your new home. This loan amount usually covers the purchase price of the new property, the outstanding balance of your existing mortgage, and any extra costs like stamp duty or legal fees.
3. Interest Payments: During the bridging period, you’ll pay interest on your total borrowing, known as “peak debt.” Many lenders offer the option to capitalise this interest, meaning it’s added to the loan balance, so you don’t need to make monthly repayments right away.
4. Repayment: When your old home sells, the money goes toward paying down the bridging loan, including any accrued interest and fees. Whatever is left over, called the “end debt,” becomes your new mortgage, which you’ll pay off like any regular loan.

Real-World Example of a Bridging Loan

Let’s say you owe $200,000 on your current home and buy a new property for $600,000. The total amount you borrow, or peak debt, would be $800,000 (plus fees). After selling your old home for $500,000, you use those funds to pay down the loan, leaving the new house and you with $300,000 in end debt. This becomes your new mortgage to repay over time.

Benefits of Bridging Loans

Bridging loans are popular because they offer a range of benefits and make an otherwise stressful event (moving home) a lot simpler. Here are the main benefits:

Fast Access to Funds

One of the main perks of a bridging loan is how quickly you can get the money. You don’t have to sit around waiting for your old place to sell while another buyer snatches your dream home from under your nose. With fast access to finance, you can act quickly to secure your new home – or new investment property – without missing out.

Convenience

Selling your home is stressful enough without the added worry of financial pressure at every turn. A bridging loan takes some of that weight off your shoulders by giving you breathing room to find the right buyer for your current home. You won’t have to settle for a low offer just to meet deadlines – instead, you can take your time and wait for the best price, making sure you get the full value from your sale.

No Need for Temporary Housing

One of the biggest perks of bridging finance is that you don’t have to live in temporary accommodation, like an Airbnb, or move in with family or friends. Rather than dealing with two moves, packing, and additional house rental costs, you can make a smooth transition from your old home to your new one.

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Drawbacks and Risks of Bridging Loans

While bridging loans can make home-buying easier, they’re not all sunshine and rainbows. You’ll want to keep a few downsides in mind before jumping in.

Interest Rates and Fees

Bridging loans often come with higher interest rates compared to regular home loans. That’s because they’re short-term and come with more risk. On top of that, you might face set-up fees, early exit fees, and other settlement costs involved, which can add up quickly.

Strict Repayment Terms

Repayment terms can be tight, with the loan typically needing to be repaid as soon as your current property is sold. If the sale drags out longer than expected, it could put you selling your existing one under financial pressure. That’s why it’s important to have a plan to avoid being caught.

Potential Financial Strain

You may have to manage two loans – your existing loan and the bridging loan. Suppose your current property doesn’t sell quickly. In that case, this can lead to significant financial strain, impacting your monthly repayments, charged interest, and overall financial situation (not to mention a few sleepless nights).

Eligibility Criteria for Bridging Loans

You must meet specific criteria to be eligible for a bridging loan.

Basic Requirements

Lenders usually require substantial equity in your existing property, a clear plan to sell your existing one, and the income necessary to service the loan. Without these, approval can be tough.

Financial Assessment

Before giving the green light, lenders will closely examine your financial situation – things like your income, outstanding debts, and the value of both properties. They want to be sure you’ll be able to repay the home loan once your current property is sold, so your finances must be in good shape.

Loan-to-Value Ratio (LVR)

The Loan-to-Value Ratio (LVR) plays a big role in your loan’s approval. Most lenders prefer an LVR of 80% or lower, which means you’ll need a decent chunk of equity in your existing home loan to qualify for bridging finance.

How to Apply for a Bridging Loan

The application process for a bridging loan is pretty straightforward.

1. Gather Documents: Organise key documents like income statements, recent tax returns, property valuations, and your credit report. Lenders will need these to assess your financial situation. If you need help preparing your application, consider hiring a reliable mortgage broker.
2. Submit Your Application: Once you’ve chosen a lender, submit your application with all the necessary information and documents. Make sure everything is accurate to avoid delays.
3. Review Terms: Take the time to carefully review the loan terms, including interest rates, fees, and repayment obligations. Understand exactly what you’re committing to before moving forward.
4. Finalise the Loan: If your application is approved, finalise the loan and proceed with your property purchase. From here, you’ll have the funds to secure your new home while selling the old one.

Tips for Managing a Bridging Loan Effectively

Managing a bridging loan doesn’t have to be stressful – follow these simple tips to stay on top of your finances and keep the process running smoothly:

• Plan the Sale: Set a realistic timeline for selling your current property. Partner with a trusted real estate agent to streamline the process and avoid prolonged market time.
• Budget for Higher Interest Rates: Bridging loans often come with higher interest rates, so it’s wise to create a budget that accounts for potentially higher repayments. Consult an accountant (we have a shortlist of top accountants in Sydney, Melbourne and Brisbane) to ensure your budget can handle the added costs.
• Make Extra Repayments: Consider making extra repayments during the bridging period if your finances allow. This will reduce your loan balance and help you save on interest in the long run.
• Stay in Touch with Your Lender: Keep an open line of communication with your lender, especially if your circumstances change. Regular updates help manage expectations and ensure you stay on track with repayments.

Alternatives to Bridging Loans

If a bridging loan doesn’t seem like the right fit, there are a few alternatives you can consider:

• Home Equity Loans: Instead of taking out a new loan, you can tap into the equity in your current property. This allows you to access funds while keeping your mortgage, providing a more straightforward solution.
• Contingency Clauses: You can include a contingency clause in your offer that makes your new purchase dependent on selling your current home. This gives you more flexibility and can help avoid financial strain.
• Renting Out Your Existing Property: If selling right away isn’t an option, renting out your current property can help generate temporary income to cover your mortgage. This can buy you time to wait for the right buyer without rushing the sale.

Conclusion

Bridging loans can be a great option to buy a new property without the rush of selling your current home. They offer flexibility and convenience, but it’s important to consider the risks, like higher interest rates and juggling two loans. By understanding how bridging loans work and having a solid plan, you can make moving from one home to the next much smoother.

Get advice on bridging loans for your specific buying scenario today. We’ve made a top 10 list of all the Sydney mortgage brokers and Melbourne mortgage brokers for you.

Frequently Asked Questions (FAQs)

1. How long can I take a bridging loan for a second property?

Bridging loans are typically available for up to 12 months. Lenders may extend this period in some cases, but it’s crucial to have a solid plan for selling your existing property just in case.

2. Can I make extra repayments on a bridging loan?

Yes, many lenders allow you to make extra repayments on the remaining balance of your bridging loan. This can reduce the overall balance faster and minimise interest costs during the bridging period. Discussing this option with your mortgage broker is a good idea, as some lenders may apply early exit fees to pay off the loan earlier than agreed.

3. How do interest rates on bridging loans differ from those on regular home loans?

Interest rates on bridging loans are usually higher than those for standard home loans because bridging loans are short-term loans considered riskier by lenders. That’s why it’s best to consult a mortgage broker to find the most favourable rates.

4. What if my current property does not sell in time?

If your existing property doesn’t sell within the expected time frame, you may need to extend the bridging loan. This can increase interest costs and cause financial stress as you make extra payments and manage two loans. Some lenders might be willing to restructure the loan, but planning for this scenario from the start is important to avoid complications.

5. Can you get pre-approval for a maximum loan term for a bridging loan?

Yes, you can get pre-approval for a bridging loan. Just like with a regular home loan, pre-approval gives you an idea of how much you can borrow, helping you plan your next steps. Remember that final approval for an eligible home loan will still depend on factors like the sale of your current property and your financial situation at the time of application.

6. Are bridging loans suitable for all homeowners?

Bridging loans are great for homeowners who need financial flexibility during a property sale. However, they’re not ideal for everyone due to higher interest rates and the risk. It’s important to evaluate your financial situation, consider market conditions, and consult a qualified mortgage broker to determine if a bridging loan is right for you.

7. Can you get a loan term, a bridging loan for an investment property?

Yes, you can get a bridging loan for an investment property. The process works similarly. You secure funds to purchase the investment property while waiting for the sale of another property. Just remember that lenders will assess your financial situation and the property’s potential rental income to ensure you can service the loan. Additionally, the interest rates on bridging loans may be higher for investment properties.