Many people automatically think they need to sell first so that they have the funds to buy their new property.
However there are many reasons why it might be better to buy first before selling:
- You’ve found your dream home however its settlement date is before the date of settlement of sale of your existing property
- You need time to find the right buyer for your current home so you can achieve the best possible price
- You don’t want to disrupt your family during the selling period by having to move into temporary accommodation
- You can spend the time making small cosmetic improvements before selling and having the house vacant could make it easier to return a better selling price
What Is A Bridging Loan?
Bridging loans also known as bridging home loans or bridging finance, allow you to manage two mortgages at once, by providing you with a temporary solution for about six months whilst you finalise the sale of your existing property. A bridging loan is normally valid between 3 and 6 months and can be extended under certain conditions.
Why Bridging Loans?
A bridging loan lets you confidently purchase your new home whilst still owning your existing property, as repayments can be structured in a way that doesn’t put you under any financial strain.
A simplified example is where your total loan amount for both your existing home and your new home is $800,000. If you’re expecting to receive $500,000 from the sale of your existing home, then your end loan amount will only be $300,000. Some lenders will only require you to pay interest on the end loan amount, rather than the total loan amount.
Therefore, even though technically you still own two houses with mortgages, repayments can be structured in a way that treats you as if you only own one home, as the interest on the balance or bridging amount is added to the loan and deducted at settlement.
Bridging finance can be useful if you think you can sell your existing home within the next six months. Note that as settlement periods can typically range from anywhere between 60 to 90 days, this means you should be in a position to find a buyer within the next three months.
Most lenders will NOT allow you to bridge finance with a total end loan greater than 80% of the value of both properties, having regard to the current loan amount and transaction costs such as stamp duty, interest charges and legal costs. Whether you can borrow under a bridging loan will therefore depend on:
- whether you have sufficient equity in your existing home;
- how much you have paid off under your existing home loan;
- the value of your new home; and
- whether you have any other sources of deposit and/or cash for your new home.
Common Bridging Loan Requirements
There are two main types of bridging loans: Full Debt Bridging Loans and End Debt Bridging Loans. Some lenders will need you to borrow the full loan amount of your current loan and new purchase, whereas other lenders only require you to borrow the end loan amount once everything is completed, i.e. new home purchased and existing home sold and settled. Your mortgage broker will be able to explain and show you how this works for your individual circumstances.
Based on our experience, lenders will typically have the following bridging finance policies:
- Total loan exposure must not exceed 80% of the total value of both properties, having regard to the current loan amount, transaction costs and the value of the new purchase;
- Home owners must demonstrate capacity to meet repayments by providing evidence of their income. Depending on the lender, this can either mean being able to afford the total loan amount, or just the end loan amount;
- Must sell their current home within 6 months (extended to 12 months in limited circumstances);
- Some lenders will automatically put the bridging facility onto a line of credit rate which is still competitive but is slightly higher than normal variable rates;
- Home owner can establish upfront the features they want for their end loan. Lenders can also capitalise/add the total interest charges during the selling period to the end loan amount; and
- Deposit may be required on the new purchase so proper planning is crucial.
How to choose a bridging loan for maximum benefit
Getting the right bridging loan structure is key. If structured correctly, generally there are no extra costs in a bridging loan and you can have a stress-free sale and purchase. Choosing the wrong bridging loan can mean your bridging facility may not be approved. For example, it you may have a better chance of success if you choose a lender that only requires proof of income for the end loan amount and not the full loan amount.
As well as different loan types, there are also two methods of structuring bridging loans:
- The one loan solution(or peak / total loan amount loan) allows you to add or capitalise repayments for both properties to the end loan, meaning you don’t have make any extra repayments during the bridging period; and
- The two-loan bridging finance solution (or end loan amount loan) requires you to make loan repayments for both properties throughout the bridging period.
For either type of bridging finance, different lenders have varying eligibility criteria, interest rates and repayment requirements.
A bridging mortgage specialist will have the appropriate tools and expertise to assess what type of bridging loan and structure is best your financial circumstances as well as accurately estimating loan repayments and the end loan amount.
Mortgage Corp Bridging Loan Success Story
Below is another example of how we helped a client use bridging finance successfully. All figures used are for illustrative purposes only.
Example: Bought a dream home at auction the same weekend when bridging finance was approved
A couple with three kids found the perfect house – only problem was that it was about to go to auction that weekend – before they had even listed their own home or gotten their financing approved. They were able to obtain pre-approval for bridging finance within a week and bid successfully at the auction.
- Estimated selling price = $550,000
- Less: Remaining mortgage = ($50,000)
- Less: Estimated selling costs e.g. agent fees = ($15,000)
- Total proceeds of sale (profit) to be used towards the new house = $485,000
- Estimated purchase price = $650,000
- Estimated stamp duty, transaction costs and interest for 6 months, plus small buffer for contingency = $75,000
- Less: profit from existing home = ($485,000)
- New loan amount = $240,000
Based on these estimates, the total bridging loan needed was $790,000 to cover:
- The estimated cost of the new home including transaction costs of $725,000;
- The remaining mortgage on their existing home of $50,000; and
- The estimated costs to sell their existing home of $15,000.
However because the $485,000 profit on the existing home would be able to be applied towards the purchase of the new property, the total new loan amount would only be $240,000.
With our chosen lender, the clients only had to pay interest on the $240,000 until they sold their current home and not on the $790,000, resulting in significant monthly cashflow savings, as the interest was deducted from the sale proceeds a few months later when they eventually sold their existing home.
You don’t have to sell your house before purchasing a new home! But it’s important to remember that bridging finance is just one of many potential solutions so you should consider all your options before going down this path.