What is a bridging loan?
A bridging loan is a short-term loan which can be used as a stopgap measure when you need temporary finance. Available to fill the financial gap between the purchase of one asset and the sale of another, bridging loans are commonly used in the property market to facilitate the buying of a new house, before the sale of the old one is finalised.
Imagine that you have found your perfect new house, but you have yet to find a buyer for your current house. You were depending on the money coming through from the sale in order to purchase your next house, but now you don’t want to lose the new dream property you have found.
A bridging loan can be used to fill in the missing link of the financial chain by providing you the money to buy your new home before you sell your old one. You can then repay the loan in full upon the sale of your existing property.
How does it work?
There are two types of bridging loans: open and closed.
Closed loans have an agreed upon exit date, by which the loan should be completely repaid. Typically, closed loans are only granted to people who have already exchanged on the sale of their current property, as such sales are unlikely to fall through.
Open loans have an open-ended time period for completion and are available for people who have yet to find a concrete buyer for their property. Loans under these circumstances are more risky to the lender, so they are likely to require a lot more information from you before granting the loan. They may ask for proof that you intend to sell the property, as well as requiring a high equity value in your current property and a realistic exit strategy for the loan. You will have to make regular interest payments until the time you are able to pay off the loan in full.
How long is a bridging loan?
The usual maximum length of a bridging loan is twelve months, though extensions may be available through negotiation. There is no minimum term, with bridging finance lasting only one or two days in some instances.
Advantages of a bridging loan
Bridging finance can really help out when quick finance is needed, but it’s not the only option out there. Let’s have a look at the benefits of choosing a bridging loan:
- It’s possible to buy your dream home before selling your old one, an opportunity you might otherwise have to miss.
- Avoid having to pay two mortgages at once.
- Successful payment can boost your credit rating significantly.
- Much faster processing than a mortgage, allowing for quick purchases and sales.
Disadvantages of a bridging loan
Don’t be fooled into thinking bridging finance is an easy way out of financial jams. If not managed properly, this option can lead to disaster.
- It’s risky. If anything goes wrong, you could end up owing a huge amount of money with no way to repay it. The sale of your house could fall through, it might take longer than expected to find a buyer, or you may sell it for less than you expected. You need to plan for these scenarios before applying for a bridging loan, otherwise you may struggle with repayments.
- It’s expensive. As this is a fairly risky move for a lender, bridging loans tend to have extremely high interest rates compared to long term finance. They also tend to have set up fees and other expenses. This can add up very quickly and you may that find a bridging loan costs you tens of thousands of dollars.
- Needs to be repaid quickly. If you encounter any obstacles which delay payments beyond the allotted time, you could default on the loan.
- You could be putting two properties at risk. If you take out a mortgage to pay for one home, while putting another house up against a bridging loan, you will have to pay for both loans at the same time. If you are unable to afford both repayments every month, you could end up losing one or even both properties.
- Few mortgage lenders may be willing to give you a home loan if you have existing bridging finance with an unapproved vendor.
- You MUST have a dependable and realistic way to repay the loan quickly. As solid exit strategy is an absolute necessity, or you may struggle to make the necessary payments in time. Good financial planning and backup plans are a must.
Who can benefit from a bridging loan?
A bridging loan is useful for people in a few situations, including:
- You have found a buyer for your old property and have reached a concrete agreement, even if payment hasn’t come through yet.
- You haven’t yet found a buyer, but have realistic expectations of selling the property within the next few weeks.
- You are purchasing a property as a short-term investment, with the intention of renovating and with a realistic expectation of selling it within a short turn-around time.
- You are doing renovations on your new property and want to stay at your old house until the building work is finished.
No matter what your financial situation, the key to successfully managing a bridging loan is to have a realistic exit strategy. Even careful financial planning is subject to fluctuations in the property market and the possibility of unforeseen complications can make bridging finance a risky option. It’s a good idea to seek professional advice before choosing to apply for a bridging loan; contact us for advice on whether bridging finance is a good option for you.