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Bridging Loans Explained

Monday, August 20, 2018

Buying property can be challenging, especially if you are selling your old house and purchasing your dream home simultaneously. After all, it might take a while to offload your previous home. It could leave you without enough funds to secure your new property. Luckily, a bridging loan can help you avoid the dilemma.

Bridging Loan and How It Works

A bridging loan is a short-term funding choice. As the name implies, it is used to “bridge” the gap between the sale of one property and the purchase of another.

The bank typically works out the amount of the loan by combining your new home's value with that of your existing mortgage and then subtracting the assumed sale price of your existing property. The result is your “end debt” or “ongoing balance.” It also represents your bridging loan's principal. The bank will then evaluate your capacity to pay off this end debt.

Types of Bridging Loans

There are two types of bridging finance open for homeowners – Open and Closed Bridging Loans.

  • Open Loans: This is for buyers who have found the right property but needs to have their repayment options open because they don't know when they can pay their loan. For instance, the building is already on the market but has not received any offers yet. Since bridging loan view these loans as high risk, the interest rates are often higher.
  • Closed Loans: This is the more popular option between the two. It's often used to buy new property while waiting for the sale of the previous home to be completed. Since sales after the exchange of contracts have a completion date, this transaction is considered safe and lenders are willing to give a bridging loan fast (UK external link).

How to Qualify for a Bridge Loan

A bridge loan is more difficult to secure since it's considered riskier. But there are several things you can do to improve your chances of qualifying for fast bridging loans.

  • Make sure you have the necessary equity: While there's no fixed rule regarding this, you'll have a better chance if you have 50% or more in capital to make bridge financing worthwhile.
  • Meet the common serviceability requirements: This entails providing proof of your employment status, present income, expenses, and various supporting documents. Treat it as though you're applying for a standard refinancing.
  • Check your credit rating: Most successful bridge financing candidates have a history of proper credit. You should ideally have a credit rating score of 740 or above when applying for this kind of loan.

Pros and Cons of a Bridge Loan

As with other loans, there are pros and cons to getting a bridge loan. It's best to weigh them first before deciding if you want to pursue this option.

Pros:

  • You can buy the property you want immediately.
  • You can secure a better price for your home. A bridge loan will ease the pressure of having to sell your home quickly. The extra time can help you obtain a better offer.
  • Most banks now charge bridge financing the standard interest rates.
  • You can avoid the cost and hassle of having to rent and move out twice.

Cons:

  • Interest is compounded on a monthly basis. So the longer you take in selling your home, the accrued interest will keep rising.
  • You will be paying for two valuations. The cost of one appraisal is around $200 to $220, and with a bridge loan, you have to pay for both your existing home and new property.

Two Things to Consider When Getting This Loan

While this type of loan might appear as a godsend, there are two things you have to consider:

  • Loan Term: This is an interim loan so you'll have a shorter payment time. It's also typically fixed term, although some loan companies are amenable to negotiations. Make sure you ask your bridging loan broker about how delayed payments affect interest rates and whether there are pre-payment charges.
  • Interest Rate: Make sure you know how much you'll be paying for this loan. Check the total loan amount plus interest rate and carefully consider whether it's worth the cost. Improve your odds of getting a good deal by comparing interest rates.

Conclusion

Bridging loans are a great option if you have to purchase property quickly. But like any other loan, this is not something that should be taken lightly. Make sure you weigh the pros and cons first and talk to the best bridging loan broker before you make a decision.

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