Bridging finance is a term often thrown around in client meetings but not many people really understand how this policy works. So lets start at the top and work our way down.
Imagine that you have seen your dream home come up for sale and you haven’t sold your current property yet or even considered selling it yet – then you might need bridging finance.
In its simplest definition, bridging finance is a type of loan that enables you to buy a property and settle it before you sell your current one. So you can buy before you sell!
Bridging finance enables you to fund the purchase price of a ‘to be purchased’ property, usually in its full entirety plus closing costs (ie stamp duty and legal costs) and allows you to keep your current property and sell it within a reasonably short time frame (less than six months ideally). The lender charges you interest on the bridging loan and adds it to the balance each month until you pay it down with the sale proceeds of your existing property (less any existing debts/costs).
Let’s look at a simple example. Say you own your current home worth $1.0m and you owe $500k to the bank already (a 50% LVR / Loan to Valuation Ratio), you haven’t sold it and you might not even have it on the market yet, and you want to buy an amazing new home that you have seen for $1.5m – you might need bridging finance.
The purchase price can be funded with a new loan of say $1.6m to say cover stamp duty. At peak, you will owe $500k (existing) plus the $1.6m so call it $2.1m owing. If you have any cash deposit you could use it to reduce the total loan size required.
This $2.1m loan does not usually need you to make monthly repayments on the bridging component (ie the $1.6m loan) but you do need to keep repayments up to date on your current home loan. Interest however does accrue daily on the bridging loan component and is added monthly to the balance. This can get pretty expensive if you are in a bridging position for too long.
Of course, the main pro of this structure is you might be able to buy a property before you sell and minimise the risk of having to move twice if you sell first and can’t find your next home before the settlement of your current home. Furthermore, lenders will give you a loan size (in the short term) much larger than what your income might otherwise support to hold both properties for a period of time.
So what are the cons – well to be honest there can be a few and this list is by no means totally exhaustive so lets go through them;
Market Risks
Without doubt, the biggest risk of using bridging finance is mainly around factoring in that you may not sell your current property in time or be forced into a situation that makes you accept a lower price than you might have otherwise been happy to accept. A falling market can be a risky place to be in a bridging finance position so being realistic in what you would sell for is an absolute must.
Costs
Like any mortgage interest is calculated daily and charged monthly. With a bridging loan is the same but a little different. You must keep repayments up to your existing loan balance (or a calculator whereby the lender works out what the approximate loan balance will be at the end of the bridging period). The bridging loan interest is still calculated daily (usually at a higher rate) and the interest is added to the loan balance each month and paid out with the sale proceeds at the end of the transaction.
Timing
Most lenders will want you to be in a bridging finance position for not more than six months and in some limited cases up to 12 months. But remember a bridging loan is usually a very large sum of money that you have borrowed and while you may not need to make monthly repayments the interest accruing could be adding up quite quickly.
The good news is that if you can negotiate a longer settlement on the property you have just purchased you might not need bridging finance for a very long time frame or at all. This is because bridging finance only kicks in from the settlement date of the purchase property. We can help inform you of what sort of solutions and purchase negotiations might work as an alternative to bridging finance that could help save you a lot of money and stress.
Market conditions
Bridging finance favour certain market conditions better than others. As a general rule, a declining property market could be risky if you are using bridging finance and you have purchased before you sell. If the sale of your property takes longer than you anticipated and you are unable to meet market conditions the sale price you might be able to secure as the weeks and months roll on could be accelerating down to your detriment. Conversely, in a rising market, the opposite can be true – you bought a nice new expensive home before prices take off and you are selling your old home in an environment that favours you as a vendor. There is a degree of luck to this so it might not be for the faint-hearted unless you go into a structure with your eyes completely open.
Deposit
So we have identified that bridging finance might be an option but you need a cash deposit to secure your new home on the auction day! This is often an overlooked consideration by many buyers – but doesn’t the bank just give it to you I hear you ask? Not quite – you need to have finance approved to release equity against your current property first to release the deposit required (if you don’t have sufficient cash) or utilise redraw or offset funds to pay the required deposit. Increasingly we are seeing vendors accepting deposits less than the standard ten per cent deposit with five per cent becoming more common especially to bring more bidders to an auction or to accommodate a buyer like yourself who may be interested in trading up to a new property using bridging finance.
There are also options outside of using a cash deposit that we can discuss with you like using a deposit bond (basically an insurance bond issued by a reputable insurance company), a bank guarantee (increasingly rare these days), as well as a few other options that we can discuss with you.
Servicing requirements
This is just mortgage jargon for ‘can you afford the loan’. Lenders have a myriad of metrics that they assess your capacity to meet repayments when interest rates rise. With bridging finance there are a few extra variables to consider which can stress your ability to ‘afford’ the end debt loan amount once you have sold your current property. These variables relate to lenders applying a discount of usually about 15% of the current valuation of your home to ensure that in a forced event you could actually sell and settle your property which would in this worst case result in a sale proceed being reduced and thus the ultimate loan you require increasing. Furthermore, the lender will add up to twelve months of interest on the bridging loan amount (in addition to the sale price discount) to ensure that the larger loan at the end of an extended period could be closed out and still be affordable. The lender of course will only charge you for interest that you used which is why it pays to minimise a bridging loan time frame. We can help you navigate the ins and outs of how lenders assess this risk and apply it to your personal scenario.
Complexity
Not all lenders in the Australian mortgage market are prepared to offer bridging finance and pretty much each lender who does has a different process and assessment policy on how they interpret your structure before they will approve you – lucky for you we are experts at navigating this on your behalf. Many lenders make it a requirement that you are an existing borrower of their institution before they are happy to extend a bridging finance product to you. Because the funding and legal documentation required to be in place for bridging finance is only usually for a short period of time (under six months usually and often just a few weeks) the interest rate charged on the bridging loan component is often not discounted and will likely be at a much higher amount than what your ‘end debt’ loan will be one you have sold your current home. While this might be fine to achieve the property purchase you want, the cost and stress of bridging finance could add up to be a very expensive solution without the right advice.
Please feel free to contact us on 03 9939 7576 and ask for Clint or one of the team to help you out. We a sure you will love speaking to an experienced person and not a call centre!
