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What is a bridging loan?

March 23, 2022
by
Craig Gibson

Doorsteps is here to reimagine the way real estate works in Australia, and part of that mission involves helping to simplify the often complicated and stressful steps of the buying and selling process. It's important to understand what options are available to you when buying and selling at the same time. One option to consider is a bridging loan. 

In this article we'll explore:

  • What is a bridging loan?
  • Are there different types of bridging loans?
  • How does bridging finance work?
  • How do you qualify for a bridging loan?
  • Bridging loan pros and cons
  • What else needs to be considered?
  • Are there alternatives to bridging loans?
  • Bridging loan FAQs

What is a bridging loan?

A retired couple discussing taking out a bridging loan

Need to buy a new property before you sell your current home? 

Buying and selling at the same time can be a tricky time to navigate, especially from a financial point of view, with cash flow being the main obstacle. That's where bridging loans come in—to help cover this period, so you can buy a new property without having to sell your home first. This takes away the stress of trying to align settlement dates, gives you more time to sell your current home and allows you some breathing time to buy a new property.

A bridging loan—also known as bridging finance or a relocation loan—is a short-term loan to enable you to purchase a new property while you sell your existing property. A bridging loan can also help you build a new home while living in your current property. 

They are issued by institutions like banks and dedicated home loan lenders who usually provide the mortgage on both properties during the bridging period. 

In terms of timeframes, most bridging loans must be repaid within 12 months, though this depends on the type of bridging loan you take out. 

Are there different types of bridging loans?

Yes, there are actually two types of bridging loans aimed at people in different situations:

Closed bridging loans

A closed bridging loan is best if you have a definite sale date and you know when you will receive the funds from the sale. The loan typically has a shorter, defined timeframe, and you repay the bridging loan (plus any fees and interest) on the date your original home sells.

Open bridging loans

An open bridging loan is best if your current home sale is more open-ended, with no defined sale date. Due to the unknown timeframe, this type of bridging loan is often for six to 12 months.

Let's now find out how they work.

How does a typical bridging loan work? 

Even though a bridging loan is a single product, it can be broken down into three elements:

  1. The balance of the loan on your current home.
  2. The purchase price of your new property.
  3. The interest payable on the loan, along with any fees and costs associated with the loan.

Let’s see how it all works in this example. 

Bridging loan example: 

Adam and Kim have $100,000 remaining on the mortgage of their current home, and they're looking to upgrade. They've found their new dream home and they want to buy first and sell later to make sure they don't miss out. 

They need $400,000 to purchase their next home, so they apply for a bridging loan that combines their current debt of $100,000 with the new $400,000 loan, totalling $500,000. This amount is called 'peak debt' and is what they will need to repay (plus interest) once they successfully sell their current home. 

With that money, Adam and Kim can go ahead and purchase the new property without having to worry about selling first. Once they then sell their old home, they can settle the bridging loan. In this case, they make $400,000 on the sale. This goes towards paying off their bridging loan. 

The difference (The $500,000 loan, less $400,000 paid back from the sale = $100,000) now reverts to a standard home loan on their new home with regular repayments. 

Lenders will usually roll over the interest from the bridging loan into your new standard home loan, or they may also offer the option of settling it when you settle the bridging loan.

How do you qualify for bridging finance?

In terms of qualifying for a bridging loan, lenders are looking for similar criteria to a regular home loan, including that you have:

  • The ability to repay the interest on the loan during the bridging period, with proof of a steady income, employment status, and a record of all your outgoings.
  • Enough equity—typically 20 per cent—either in cash or in your current home. 
  • Saved a deposit toward your new property, typically 5 to 10 per cent.

Before signing up for any financial product you should weigh up all aspects of the offering to be sure it suits your personal circumstances.  

Bridging loan pros and cons

Let’s start by looking at the upsides of bridging loans and how they can help you.

  • Bridging loans give you the flexibility to stay in your home while you buy a new property.
  • They give you time to wait for the highest possible offer for your current home.
  • You don’t have to wait for your existing home to sell before buying a new property.
  • Living in your home means you don’t have to pay rent while you shop for a new property.

Some of the downsides of a typical bridging loan include:

  • The interest on bridging loans is more than standard home loans.
  • There are costs you need to budget for, like the interest on the total loan amount, payable when the loan period ends.
  • If your home takes longer to sell than you expect, more interest will build up, making the loan more expensive.
  • If you get a lower price for your current home than you expect, you will have a larger loan to repay in the future.
  • It can be difficult to get approval from your lender.

What else needs to be considered?

While a typical bridging loan can be the leg up that some buyers need to allow them to buy their next home before selling, it's important to keep in mind that there will still be a range of expenses that the loan won't cover. 

For starters, you'll need to have a deposit saved up for your new purchase—usually 5 or 10 per cent. You'll also need to pay costs like stamp duty, conveyancing and Lenders Mortgage Insurance (LMI). These are out of pocket expenses that you will need to have saved for yourself, so be wary of this when working out what you can afford. 

Are there alternatives to bridging loans?

It's true that a standard bridging loan is not for everybody. They're generally costly when factoring in higher interest rates, they can also be difficult to get approval for, and they don't take into account other expenses in the process. Basically, it might not be the magic solution to the stress and financial burden that buying and selling at the same time brings. 

Thankfully, there are some new companies looking to solve this problem, like Doorsteps, who will be offering an innovative financing solution for those looking to buy and sell at the same time. This will launch in 2022.


Frequently Asked Questions

What can I do instead of getting a bridging loan?
Can I use a bridging loan to build a new home?
How much can I borrow with a bridging loan?

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