It happens all the time. You finally find that great next home you have been desperately looking for and you want to make an offer, like now, before you have sold your existing home. You can just picture yourself relaxing out on that back deck with a wine or two – it’s going to be great!
But what if you don’t settle on your existing property before the new place does and you need lender finance to tide you over? Enter the need for a Bridging Finance.
What exactly is a Bridging Loan?
Many people don’t understand what bridging loans are until it is too late. It’s best to understand what they are before you ‘buy before you sell’.
As the name implies a Bridging Loan provides a bridge between two loans, whereby for a period of time there will effectively be two loans to cover the purchase of a new property before settlement on the old property has occurred. The lender takes security over both properties and lends against them until the sale and purchase process on both has been completed.
How do they work?
There are a few (scary sounding!) terms when it comes to Bridging loans.
Peak Debt – this is the anticipated highest debt amount which includes your existing mortgage, new purchase costs and anticipated interest costs that accrue over the life of the Bridging.
End Debt – this is the anticipated debt level following the sale and settlement of the original property. This in effect is your new mortgage amount.
Capitalised Interest – interest is accrued and added to the loan balance during the period of Bridging
Example: May-Ann & Ben have purchased a property for $1.3m (including purchase costs). They still have $400,000 owing on their current property which they estimate will sell for $1m. In this case their “peak debt” begins at $1.7m.
Bridging loans are interest-only, so during the bridging period of say, six months, interest will be compounded monthly on your ongoing balance at the standard variable rate. The interest bill will then be added to the ongoing balance when you sell your house, and this amount becomes the mortgage on the new property.
May-Ann & Ben’s lender has a standard variable rate of 5.0% so over a period of 6 months their will incur interest of $42,500. As they are not paying any principal at this stage, this interest will be “capitalised” and added to their “peak debt” so it rises to $1.742m.
While the interest rates on bridging loans are now comparable with ordinary mortgages, don’t forget that you are still essentially carrying two mortgages, and during the bridging period you are not paying anything off. The longer you take to sell your existing home, the higher your interest bill, and hence your new mortgage, will be.
May-Ann & Ben sell their house and achieve a sale price of $970,000 (after agent costs). The loan is then reduced by that amount to $772,500 which becomes the “End Debt”.
Some lenders require a client to be able to service the loan at Peak Debt, meaning they have to have a lot of surplus funds every month, whilst others allow servicing on End Debt alone.
So what are the Pros and Cons of Buying before you sell and Bridging Finance?
It’s best to chat to your Mortgage Broker to weigh up the pros and cons for your particular circumstance, but generally speaking;
- You get to secure the next roof over your head (and that awesome deck!) before you sell the old one
- It reduces the rush and stress of trying to match up two settlement dates exactly, or leaving you with no-where to live for an unknown period
- With finance secured you may feel like you are in a better bargaining position when selling your existing home
- Bridging Loans are now comparable to standard variable rates
- With interest only Bridging Loans, you aren’t required to pay the interest at the time, it is added to your loan amount at the end of the bridging period.
- There is a pretty hefty cost involved during a Bridging Loan Period
- For every $100,000 in additional costs you take on, you are paying an additional $416 a month on top of your existing loan. So if you buy a $1m house, that’s an additional $4,160 a month, every month while the Bridging Loan is in place
- There are likely to be loan establishment costs
- Different lenders have different requirements for Bridging Loans, many lenders will require you to be able to afford to pay the ‘peak debt’ amount, something that is out of reach for most people.
- It’s fair to say lenders don’t like doing Bridging Loans as it is a lot of work for a short period of time, so they don’t always make it easy! Once again your broker can help you work out which lender options will work for you if you are Bridging.
And finally a small cautionary tale. Lenders also have minimum time frames for Bridging Loans. A recent client of mine had a 3 day period between the purchase of their new home and the sale of their existing one. There is no lender that will be able to execute a change of title and settlement of loan within that time period. Most banks will insist on a minimum 2 week Bridging Loan period.
So to Bridge or not to Bridge?
In most cases you are better off looking to sell and settle on an existing property before purchasing a new one, or line the settlements up to be on the exact same day. But real life (and buying property!) can get in the way of this. So if you are thinking about buying before you sell, or you have bought before you have sold get in touch to chat through your Bridging Loan options.
Thinking of buying before you sell?
Call Douglas today on 0408 671 524
This information is of a general nature only and does not constitute professional advice. You should always seek professional advice in relation to your particular circumstances.