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Bridging loans explained

27/10/2020

We answer some of your questions around how bridging loans work.

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Thinking of moving to a new home? You’ve probably already heard more than enough about the different home loan types out there and what they offer. But we have another one for you! Read on to find out all you need to know about bridging loans and whether they could be a good option for you.

What is a bridging loan?

A bridging loan is a temporary loan that “bridges the gap” between one loan and another, typically the sale of one house and the purchase of another. This allows you to fund the purchase of a new home while you wait for the sale of your previous one. Essentially, you take out a second loan on top of your existing one until the home sells and the loan closes.

These loans are not for everyone and are designed to bridge a short period of time, normally less than a year. They are typically backed by another asset, often the property you’re selling, so your bank will require you hold a certain amount of equity in your existing home. Bridging loans may also come with higher interest rates than standard long-term home loans.

Who would want a bridging loan?

Buying a house when you already have one can be a tricky process. Firstly you have the old ‘buy first or sell first’ conundrum. Most people sell their old home before buying another, but sometimes buying first may be a better option for you. If you do decide to buy first, you need to figure out how you will afford the new house before you receive the proceeds from the sale of the original house.

One option is to negotiate a contingency plan with the seller. This means you enter an agreement with the seller stating that under certain conditions, such as your home not selling within an agreed time period, you don’t have to go through with the purchase. This can be a great option to reduce the financial risk of carrying two loans at the same time.

However, sellers aren’t always willing to agree to these plans. In this case, a bridging loan could be an option. This allows you to take your time to sell your home and get the price you want.

How does a bridging loan work?

Bridging loans can work in different ways for different circumstances. More often than not they are just like a normal loan with interest-only repayments, until your home is sold and the loan can be repaid in full. Therefore the bridging loan is used to pay off any existing debts on a previous property, and then pay the deposit on the new property. In other cases the bridging finance can be used as a second loan on top of the existing home loan, to allow you to finance another home.

Considerations

Whilst short-term bridging loans can be a great solution to bridge a financial gap, they don’t come without risks. Here are a few of the main considerations to think about before you take out a bridging loan:

  • Interest rates

Interest rates on bridging loans can be higher than regular home loan rates. Interest is normally charged monthly, so if your home takes a while to sell, you could end up paying a lot of interest. If this length of time goes beyond the agreed bridging period, the interest rate may also go up.

  • Requirements

Lenders will need to assess your eligibility for a bridging loan. They will often require a certain amount of equity in your existing house to be able to put down a substantial deposit on your new home. If you don’t meet this requirement, the lender may apply a higher interest rate.

  • Financial stress

While these loans are a great short-term solution, make sure you’ve considered how you will pay for two loans plus interest. You will have to ensure you have the finances to cover all these payments and manage both loans for a period of time.

Bridging loans can be a good solution for certain people and certain circumstances, but they aren’t for everyone. Make sure you’ve thoroughly researched all the terms and conditions and done your homework before you go ahead with a loan.

This article is intended to provide general information of an educational nature only. This information has been prepared without taking into account your objectives, financial situation or needs. Therefore, before acting on this information, you should consider its appropriateness having regard to these matters and the product terms and conditions. Terms, conditions, fees, charges and credit criteria apply. Information in this article is current as at the date of publication.

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