If you’re looking to move houses and plan to use the money from the sale of one house to purchase another, you may face a potential hurdle. Property sales can sometimes take time and you may find a house you want to purchase while your current house is still on the market. A bridging loan is one option that could potentially help you overcome this hurdle.
What is bridging finance?
A bridging loan is a type of finance that enables you to finance a new property while your existing one is awaiting a buyer. Typically, bridging loans are for short-term needs, such as bridging the financial gap between property settlement dates.
How do bridging loans work?
A bridging loan is a short-term loan that typically lasts for 6 to 12 months. Their purpose is to assist borrowers in covering the shortfall in funds when acquiring a new home.
While a bridging loan may be helpful, it’s generally more expensive than a traditional mortgage. You could expect to pay anywhere around 2 to 5% more than the standard variable rate on a bridging loan. Some lenders may have strict eligibility requirements, such as having substantial equity (up to 50% in some cases).
Two components typically constitute a bridging loan: the amount owed on your current mortgage and the price of your new property.
To calculate the value of your new loan, the lender will subtract the anticipated value of your current home from this peak debt – this is known as the end debt. The end debt will revert to a regular principal and interest mortgage once your current home is sold.
It’s worth noting that bridging loans are often interest-only. During the bridging period, you are required to pay interest while simultaneously repaying your current mortgage. However, some lenders may allow you to add the interest payments on the bridging loan to the principal amount. In this case, the interest will accumulate and increase the size of your debt throughout the bridging period.
What are the potential benefits of a bridging loan?
- The biggest advantage is that it allows you to purchase a property you like without rushing into selling your current one.
- Bridging loans typically only charge you interest during the bridging period. It may be possible to add the interest to the loan amount which could make it easier to manage your finances during the transition phase instead of making full repayments on two mortgages.
- Buying a new house before selling your current one can save you money on temporary accommodation expenses after selling your home.
What are the drawbacks of bridging finance?
- If it takes longer to sell your house, you may end up paying more interest. Opting to add interest to the principal may help you manage costs during the bridging period, but it could increase your loan size substantially.
- Property markets are unpredictable and you don’t really know how much a property will fetch until it’s actually sold. There’s a risk of financial strain if your home sells for less than expected. This may lead to a larger loan size and higher monthly payments, potentially causing financial stress.
- If your current lender doesn’t offer a bridging loan, you may need to refinance, as the lender offering you it may want to take over your existing loan. This is likely to add to your costs, including exit fees (for fixed-rate loans) and valuation fees for both properties.
When you might need a bridging loan?
These loans are typically suitable for short-term financing needs, such as when you are trying to buy and sell simultaneously. If you want to move houses, there might be a gap between selling your existing property and buying a new one. Bridging loans help cover your finances during this period, especially if you need sale proceeds from the current property for the new one.
A bridging loan might also be an option if you want to substantially renovate a new property while waiting to sell another. However, you may need substantial equity to qualify for a bridging loan and the interest rate is likely to be higher than a standard mortgage. It could help to speak with a mortgage broker to understand whether they are suitable for your situation.
By Vidhu Bajaj,
Hashching Content Writer