What is a bridge loan?

A bridging loan is often a second loan taken out in addition to your existing house loan. This implies that you have two loans and are often charged interest on each of them throughout the "bridging period" while trying to sell your previous property.

In most cases, a bridging loan:

• is a sort of interest-only mortgage.
• has a monetary worth determined by the equity in your existing property.
• has a limited loan term
• contains additional terms, such as a lender's ability to charge a higher interest rate if the property is not sold within a particular date.

Bridging loans are handled differently by each lender:

• Some loan types require you to simply make payments on your old loan until you move into your new home. However, throughout the bridging term, the interest on the bridging loan is applied to the outstanding balance of your bridging loan. When your existing house is sold and the original mortgage is paid off, you begin making payments on the principal of the bridging loan (plus the added interest).
• Other loan arrangements may compel you to start making payments on both loans as soon as you open the second one.

When you sell your present house, the original mortgage is cancelled, and the bridging loan is frequently changed into your preferred home loan for your new property.

It is crucial to realise that the impact of compounding interest – which is likely to be doubled in this situation owing to having two loans – means that the longer it takes to sell the old property, the more interest will accumulate and the more you will have to pay for the loans in general. Interest is computed daily and may be levied monthly, so depending on the amount borrowed, this might rapidly build up.

It may also be worthwhile to carefully evaluate the duration of the bridging period, which is typically six months for acquiring an existing house and 12 months for purchasing a new property. Lenders frequently include loan restrictions that allow them to impose a higher interest rate if you do not sell your home within the specified time frame. And, as one lender puts it, if you don't sell your home, the lender "may become engaged to sell the property" in order to satisfy the loan.

Requirements for a bridging loan

A few conditions may apply to bridging loans that would not apply to other forms of house loans. Some of the criteria and factors that may apply, depending on the lender and the individual product you select, include:

• Maximum LVR requirements, which means you may need a deposit of a particular amount to apply, such as a 25% deposit. Some lenders may additionally need you to have a certain amount of equity in your current property, such as 20% of the peak debt.
• The bridging loan's maximum loan period, for example, your present house may need to be sold within 6-12 months.
• During the bridging term, you may not be able to use the redraw facility on the bridging loan.
• Bridging loans may not be provided for the acquisition of a firm or a strata title.

It's worth noting that the economic consequences from the COVID-19 outbreak has affected the way many lenders evaluate home loan applications. Depending on your circumstances and the lender you pick, this might result in processing delays and tougher loan requirements.

Advantages and Disadvantages of bridge loans

Bridge loans, like any other lending product, offer advantages and disadvantages for borrowers. Before applying for any type of loan, it's critical to understand and assess the benefits and drawbacks.

Advantages of bridging loan

• Convenient: Bridging loans may enable you to purchase a house right away without having to wait for your present home to sell.
• Repayments: Depending on how your loan is arranged, you may only have to make payments on your current mortgage during the bridging period.
• Avoid renting: If the timing of the bridging loan and the sale/purchase is perfect, it may be feasible to avoid the costs and inconvenience of having to rent a property between the sale of your previous home and the settlement of your new home.

Disadvantages of bridging loan

• High-interest rates: Because lenders have less opportunity to earn a profit on a bridge loan due to its shorter tenure, they tend to demand higher interest rates for this sort of short-term financing than they do for traditional loans.
• Origination fees: Typically, lenders impose costs to "originate" a loan. Bridge loan origination costs can be expensive, as much as 3% of the loan value.
• Equity required: Because a bridge loan utilises your present house as collateral for a loan on a new home, lenders frequently need a particular percentage of equity in your current home to qualify, such as 20%.
• Sound finances: To be eligible for a bridge loan, you normally need to have good credit and a solid financial situation. Minimum credit ratings and debt-to-income ratios may be imposed by lenders. In general, obtaining a bridge loan may be tough if your financial status is precarious.

A bridge loan may appear appealing, but you should carefully consider the fees and hazards. Before applying, you should think about alternative possibilities, such as a home equity line of credit, personal loan, 401(k) loan, or home equity conversion mortgage. These loans may also assist you in moving out of your present house and into your new one, perhaps without the danger, interest, and costs associated with bridge loans.