A bridging loan can tide you over while you sell your home, but an impulsive decision could land you in deep water, here’s what you need to know.
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If you find yourself packing for a sudden work relocation or heaven forbid, your ex just bought the house next door, you could be needing to move in a hurry. If that means buying before you have a chance to sell, one option is to take on a bridging loan to cover the gap.
Bridging loans can tide you over while you sell your home, but an impulsive decision could land you in deep water, here’s what you need to know.
What is a bridging loan?
Bridging loans are short term loans (typically 1-12 months) and are designed to help you buy until you can sell and release your existing capital. To qualify you will need solid collateral and a good track record to offer the lender. However they can be risky and get very expensive if selling doesn’t go to plan.
How does a bridging loan work?
Bridging loans combine your existing mortgage debt with the new purchase amount, extending your leverage capacity for a 3 – 12 month window while you sell your original property. A straight forward Bridging Loan might entail a 12 month loan taken out for the new property only, whilst retaining the existing mortgage. You then pay both loans for the whole period (Ouch!)
Some loans allow you to defer the expense and have the interest added to the total of your new mortgage – but it’s really just a matter of pay lots now… or even more later. At settlement, the original mortgage is paid out and the balance goes towards reducing the new mortgage.
For example : Assuming you owe $300K on your apartment and wish to buy a home for $550K + $50K costs, your total bridging loan has a total value of $900K. The selling amount at settlement is deducted from the $900K. Then add on the capitalised interest to create your new loan/mortgage total.
My lender says I won’t have to make repayments during the bridging period, is this a good idea?
Interest rates and methods vary from lender to lender, so if you do decide to take a bridging loan, make sure you compare and shop around for the best deal.
It may seem attractive not paying any extra interest during the bridging period, but rest assured it will be added to the total amount later. This is known as capitalising your repayments – but just means deferring the pain. Your total, or “Peak Debt” will still be increasing each month and interest will be calculated on your Peak Debt, including the capitalised repayments, as you watch your debt compounding!
How much can I borrow with a bridging loan?
Borrowing capacity is usually calculated on the End Debt rather than the Peak Debt. To be eligible for bridging finance, you have to meet the Loan to Value Ratio (LVR) of your lender. The LVR is the ratio of the amount lent to the valuation of the security for example a home loan of $540K valued at $600K gives an LVR of 90%. Capitalising repayments are possible where the LVR meets the lenders requirements.
What’s the catch?
The risk is that if your property does not sell in a timely fashion, or sells for less than you hoped you may be required to make some hefty repayments on the Peak Debt and wind up with a much larger mortgage than you anticipated. Short bridging loans also put the pressure on to get your home sold quickly, perhaps for less than you hoped.
Tips to make the most of a bridging loan
- Don’t move impulsively, if spending a few months in your existing place will save you tens of thousands try to be tactical about your move.
- If you must move, or you’re about to buy your dream home, consider renting out your existing place in the short term to mitigate the cost of your peak debt (look for a lender who will allow this.)
- Make sure you budget for other moving expenses such as stamp duty, property valuations, repairs and bank or legal fees.
- Include a six week settlement period in your bridging loan time frame so you aren’t caught short.
- Shop around for the most competitive and flexible bridging loan you can find. Look for a low fixed or variable interest rate, low fees and make sure you understand any establishment costs, penalties or exit fees.
- Minimise peak debt by continuing to make repayments during the bridging period.
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