Are Bridging Loans a Good Idea? Here’s Everything You Need to Know
When you want to buy a new property, but you can’t sell your old one yet, a bridging loan can help you. However, bridging loans are not well understood by many. That’s why they don’t know that they can easily access funding through this loan type. Bridging loans are very useful if you need to borrow cash for a short period of time.
To help you further understand what a bridge loan is, here’s an article discussing how it works, what are its associated costs, and its benefits and drawbacks.
What is a bridging loan?
Bridging loans “bridge the gap” when you’re buying and selling a home simultaneously. This type of short-term loan makes sure you won’t miss the opportunity of buying that property you like because of some cash issues. It covers the price of your second property and gives you time to sell the old property, creating a bridge that allows you to move along the gap between buying and selling. A bridging loan satisfies your immediate cash flow need and moves you out of the cash crunch.
The amount that can be borrowed in a bridging loan is calculated based on your property’s equity. Typically used in real estate transactions and business while waiting for long-term financing, the application and underwriting process for this type of loan is faster than those of traditional loans. Nevertheless, a bridging loan has a limited loan term, and it must be paid back immediately because of their interest rates that are higher than those of long-term financing options. In some cases, the lender can still charge a higher interest when the property isn’t sold within a set timeframe.
How does a bridging loan work?
Bridging loans are secured by a house or any property. In general, it covers your mortgage on the existing or old property and the purchase price for the new one, which makes up your peak debt. Peak debt is the total amount you borrow from a lender. It’s the sum of what you need to borrow to buy a new property and the outstanding mortgage of your old or existing property.
When your existing property gets sold, its sale price will be subtracted from your peak debt, and what’s left is called an ongoing balance or end debt. Now, that’s the overall balance of your new loan, which will work as a common home loan henceforward.
Given that there are two mortgages at once in bridging loans, you may have interest-only loan repayments or your interest charges may be capitalised into the peak debt until your existing property is sold. Interest-only loan repayments allow you to pay only the interest rates for some or all of the term.
Bridging loans can be open or closed. When you already have a buyer for your property but haven’t settled all the paperwork needed, you can borrow a closed loan. This type has a fixed repayment date. Meanwhile, the open type has no fixed repayment date, but you should pay it off within a year. This type is available for people who have no buyers yet for their existing property.
What are the costs associated with bridging loans?
Bridge loans may be convenient to obtain temporary financing, but they have associated fees, in which the rates can vary depending on your location and the lender. These fees may include the following:
- Loan application fees
- Capitalised interest
- Facility fees
- Property valuations
- Purchasing costs
- Selling costs
What are the benefits of a bridging loan?
In addition to having fast access to funds, bridging loans still have other rewards or benefits that you may consider when deciding to get one.
- During the bridging period, you only make repayments on your existing mortgage.
- Given that you can buy a new property without waiting for your existing property to be sold, bridging loans are convenient.
- Bridging loans also enable you to make an offer on a new property without a sale contingency.
- You can avoid the cost and hassle of renting a home while you’re settling your new property and selling the existing one. You also don’t have to move twice.
What are the drawbacks of a bridging loan?
- Bridging loans are more expensive than the other types of loan because of the fees involved.
- Applying for a bridging loan requires high eligibility criteria. You must be able to pay two mortgages at the same time.
- You have to pay for two valuations, one for your existing property and another for the new one.
- Interest rates get higher if you couldn’t sell your property on time.
- There’s no redraw facility. You can’t withdraw any extra repayments you made.
- With your existing property acting as collateral, it’s at risk for foreclosure if you fail to repay your loan.
- When you end up selling your existing property for an amount that’s less than what you’ve expected, you will get a higher home loan balance to pay.
Should you get a bridging loan?
A bridging loan bridges your finance gap so you can buy a new property while still selling the other one. This type of loan may not always be suitable or available to you. However, it’s a good idea if you satisfy the equity requirements and creditworthiness, as well as when you expect your existing property to be sold within the next few months.
When planning to get one, you should always check the conditions provided by your lender to avoid complications. If they look good and acceptable for you, then you can proceed with your application. Otherwise, you should better find other alternatives to avoid getting buried in debt.
If you would like to further discuss bridging loans and know whether you qualify for one, try finding a good lender in your area. For instance, Mango Credit provides short-term financing solutions across Australia. The company offers various bridging and business loans for personal and commercial purposes.
Whether you continue with your application or look at alternatives, take your time to study your options. Understand how things work so it won’t get messy in the long term.