Bridging finance is a short-term loan of up to 12 months to “bridge” the financial gap between buying a new home and receiving the funds from selling your old one.
The loan amount is calculated on the available equity in your current home and most of the bigger lenders recommend you have at least 50 per cent equity – that means that what you owe is no more than half the value of the home.
The bridging loan is usually made up of the amount owing on your current mortgage plus the purchase price of your new property. This is known as your peak debt. For example, if you owe $400,000 on your current loan and purchase a property for $1 million, your peak debt is $1.4 million.
Once your property sells, the sale price less any upfront costs such as stamp duty, agent’s fees and legal fees is subtracted from your peak debt to leave you with your end debt. So if you sold your property for $700,000, and had associated costs of $50,000, your end debt would be $1.4 million minus $650,000, or $750,000.
Your end debt is what your new loan will be worth and it will revert to a regular mortgage.
If you don't hold enough equity in your existing home and your loan to value ratio is above 80 per cent, you may be required to take out Lenders Mortgage Insurance (LMI).
How you make payments during the bridging period depends on the structure of your loan. You might make payments only on your current loan while interest accumulates on your bridging loan and you only pay that back once you sell. In this scenario, because you’re not making payments on the bridging loan, the interest costs can accumulate quickly.
Or it could be that you pay interest only on the bridging loan while still paying your current home loan, leaving you to fund two loans at once.
Another thing to keep in mind is while you can usually make extra repayments on your bridging loan, you generally have no access to a redraw facility during the loan period.
Usually your current lender is best placed to offer bridging finance. But if your existing lender doesn’t offer it, you may need to switch and they may insist on taking on your existing loan. If you’re on a fixed rate this could prove costly.
There are two types of bridging loans:
- Closed bridging loans: These loans are used when you have a buyer for your existing property but the settlement dates don’t match up and you won’t receive the funds from your sale in time to pay for your new home. A closed bridging loan covers a set period of time. These can be cheaper than open bridging loans because they are considered less risky.
- Open bridging loans: These don’t have an agreed settlement date but are open for up to 12 months. These suit someone who has purchased a new property but hasn’t yet put their existing property on the market or found a buyer yet. If you don’t sell within the term of the loan, penalties apply.