Bridging loans explained
Why consider a bridging loan?
For borrowers in a very specific set of circumstances, a bridging loan can offer:
- Access to finance in a situation where it might be difficult to obtain a different kind of home loan.
- Flexibility and breathing room to find a buyer for your previous home after you’ve bought your new property.
- Reduced home loan repayment costs during the interim period, before your old property sells.
What to keep in mind when choosing a bridging loan
If you think a bridging loan might be worth considering, here are some key considerations to remember when comparing your options:
- While you’re waiting to sell your existing property, you’ll likely be making interest-only repayments towards your loan – so a competitive interest rate is key.
- Bridging loans typically don’t allow for lenders mortgage insurance (LMI), so you’ll need at least 20% of the end debt value in either cash or existing equity.
- Once you’ve sold your old property, your bridging loan will be converted to a standard home loan, so make sure you compare loans based on how they’ll end up as well as how they start out.
Expert tips for managing a bridging loan
Our General Manager of Money, Stephen Zeller, wants to help borrowers make home loan decisions that are appropriate for their circumstances. With that in mind, he has some tips for anyone considering taking out a bridging loan:
Stephen Zeller
General Manager – Money
Timing is everything
Because of the time-sensitive nature of bridging loans, you’ll want to try your hardest to coordinate your sale and purchase dates to cut down on bridging time and save on interest costs.
Keep a buffer on hand
Make sure you’ve got a contingency fund set aside to cover any unforeseen expenses that might pop up during your bridging period.
Compare your options!
Comparison is crucial when looking for a competitive home loan product – be sure to compare a range of offers from different lenders so you know what your options look like before submitting a loan application.
All about bridging loans
What is a bridging loan?
A bridging loan is a short-term home loan designed to help homeowners bridge the gap between buying their next home and selling their current property.
It involves a lender taking on your existing mortgage for the first home as well as providing you with a new short-term loan (the bridging loan) that covers the new property’s purchase price.
The total amount of debt taken on by the lender (between your existing mortgage and the new loan’s total amount) is referred to as your ‘peak debt’ and includes any costs of purchasing the new home, such as stamp duty and any legal or lenders’ fees.
How does a bridging loan work?
Once your current property is sold, the proceeds (after fees) will be used to pay down the peak debt, and the remaining amount will then typically be converted to a standard home loan product.
The new component of a bridging loan will usually only require interest-only repayments, meaning you won’t be required to pay down the new principal (the amount you borrowed) while it’s still at the bridging stage. Additionally, you can also opt to capitalise your interest costs into the loan, meaning they’re added to the total loan amount rather than charged as regular repayments.
However, keep in mind that you’ll be required to continue making your regular home loan repayments towards your existing home loan principal, the ‘old’ component of your bridging loan.
Types of bridging loans
You’ll generally have a choice of two different types of bridging finance, and your choice will typically be determined by how much progress you’ve made in buying your new home. Let’s go over how the two types of home loan work and explore what kinds of borrowers and financial situations they might be suitable for.
Open bridging loans
Open bridging loans are designed for prospective homebuyers who are still just that – prospective. An open bridging loan will probably be the right choice for you if you don’t have an agreed settlement date for your existing property just yet, as their longer life (usually up to 12 months) makes them suitable for those who are still looking around.
While this open-ended flexibility can be invaluable in helping you navigate both the buying and selling processes with minimal hassle, keep in mind you’ll be accruing interest charges for however long it takes you to sell your current home. If it takes you the full 12 months to sell your home, you may find yourself saddled with significant interest charges as a result.
Closed bridging loans
If you’ve got a contract of sale in place and know when settlement date will be, you could opt for a closed bridging loan. This type of bridging loan is for those working within a specified timeframe, who know exactly when their existing home is going to be sold.
At the end of the loan’s timeframe (usually settlement day), you’ll pay down your peak debt as well as any interest and fees accrued during the bridging loan term.
What are the pros and cons of bridging loans?
As you can see, bridging loans come with a very specific set of upsides and downsides. Let’s put the main points side by side to see how they stack up.
| Pros | Cons |
|---|---|
| Offers you the flexibility of buying a new home before you’ve sold your old one. | Taking on such a large amount of debt could be stressful, particularly if you’ve opted for an open bridging loan. This can also hold true for closed bridging loans, especially if there’s a lengthy settlement period involved. |
| The ‘new’ component will typically be interest-only, and you can usually opt to have that interest capitalised into the loan to reduce your immediate costs. | Opting to capitalise the interest into your loan can leave you with a much bigger home loan balance than you were bargaining on. |
| Can help you avoid renting and storage costs. | Your home may sell for less than you want due to the property value declining, or it may not sell at all – in this case, you’d most likely find yourself under severe financial stress. |
Could a bridging loan be appropriate for you?
Who’s eligible for a bridging loan?
To qualify for a bridging loan, you’ll typically want to have satisfied the following requirements:
- You meet your lender’s standard lending criteria for home loans
- Your current home is listed and available for sale on the real estate market
- You have at least 20% of the bridging loan’s peak debt in either savings or existing equity in your current home and will end up with a maximum loan-to-value ratio (LVR) of no more than 80%
- Your current home has been professionally evaluated and you have a formal property valuation you can show your
Keep in mind that your lender may have additional eligibility requirements for bridging loan applicants; you may want to speak with your lender before submitting a formal application.
Can I build a new home with a bridging loan?
Depending on your lender, you might be able to take out a bridging loan to facilitate the construction of your new home. However, you may need to satisfy extra lending criteria or face additional hurdles if you’re looking to build, such as a shorter loan term or a higher interest rate.
Can I make regular repayments to pay off my bridging loan early?
Depending on your lender, you may be able to make extra repayments towards your bridging loan to help you pay it down earlier and reduce the amount of interest you’ll need to pay all up.
Important to know
What are the interest rates on bridging loans?
Lenders in Australia will typically charge higher interest rates for bridging loans than what you’d see on standard home loans. These higher rates can be chalked up to the loan’s relatively short-term basis and the fact that they pose more risk to the lender than a standard home loan would. Most bridging loans will come with a variable interest rate; however, you may be able to find a fixed rate bridging loan that suits your needs and priorities.
And at the end of the day, you can still compare different bridging loans based in part on their respective comparison rates to help figure out which ones might offer better value, just like regular home loans!
What if I don’t sell my existing property during the bridging period?
If you’re unable to sell your existing property within your bridging home loan term, your lender may:
- Extend the loan period by a few months
- Charge you a higher interest rate and otherwise leave the loan as is
- Step in and try to sell the property for you, which may result in a lower final sale price than you wanted.
You may want to enquire with your lender regarding this potentiality and how they’d handle it before applying for a bridging loan with them.
What if my property doesn’t sell for as much as I’d hoped?
If you can’t sell your existing property for the amount you expected, you’ll still need to pay your outstanding bridging loan amount. In a scenario like this, you would want to thoroughly consult with your lender to establish your range of options and potential plans of action.
What are some alternatives to a bridging loan?
If the idea of a bridging loan doesn’t appeal to you, you could alternatively choose to:
- Commit to selling your current home before shopping around for a new house. However, this could risk the market running away from you if you can’t secure a new property in good time.
- Agree on a longer settlement period for your purchase of the new property to give yourself some extra time to sell your old home.
- Alter the purchase contract for the new home to include a ‘subject to sale’ clause. This will mean you aren’t obliged to pay for your new home until you’ve sold the old home. Not all sellers may be willing to agree to this clause, however, so this may not be a foolproof solution.
Meet our home loans expert, Stephen Zeller
Stephen has more than 30 years of experience in the financial services industry and holds a Certificate IV in Finance and Mortgage Broking. He’s also a member of both the Australian and New Zealand Institute of Insurance and Finance (ANZIIF) and the Mortgage and Finance Association of Australia (MFAA).
Stephen leads our team of Mortgage Brokers, and reviews and contributes to Compare the Market’s banking-related content to ensure it’s as helpful and empowering as possible for our readers.