A beginner's guide to bridging loans

Obeying the golden rule of selling before buying when it comes to real estate isn't always in your best interests.

After months of looking, you find your dream home in a tightly held suburb at a great price and you want to snap it up before anyone else does. But what do you do if you haven't sold your current abode, which has its own mortgage attached? One option is a bridging loan.

It does exactly what its name implies. It serves as a bridge between the sale of one property and the purchase of another. These types of loans are designed to cover the purchase price of a second property and give the borrower the time to sell their existing property.

But before you sign on the dotted line, there are many aspects to this type of loan that need to be considered, such as interest costs and conditions. Because these are short-term loans, interest costs tend to be higher - but not always.

The comparison site ratecity.com.au lists bridging loans with interest rates of 6%-plus, but none of these is from major banks.

Mortgage broker homeloanexperts.com.au, which includes the top four banks plus others on its panel, says some banks now charge standard interest rates for bridging loans.

"In the past, banks charged a higher interest rate for bridging loans, but now there are some lenders that charge standard variable interest rates," says the homeloanexperts.com.au website.

"Application fees (usually around $600) are the same and you don't have to worry about break costs or discharge fees for paying the loan off quickly. Keep in mind that most lenders won't generally approve a bridging loan if you're likely to sell the property in less than three months."

With most bridging loans you have a limited time to sell your property - usually 12 months, but sometimes less - before the loan is pulled from you.

Be realistic about price

When you sell before you buy, you know exactly how much you can afford to pay for your new home. When you buy before you sell, it's very important to have an accurate view of your current home's worth so you can set a realistic budget for your new place.

Because many of us tend to exaggerate our property's worth, you should consider investing in a valuation from a valuer. This will generally be a lot more realistic than the view of an optimistic real estate agent.

You also need to be aware of whether prices in the area you're selling in are rising - very good if they are - or falling, which is not good at all.

You don't want to be forced to sell your original property at a lower price than you were hoping just to meet the conditions of your bridging loan.

Most people will approach their current mortgage lender if they want a bridging loan. But if your lender does not offer them, or you're not happy with their offering, you will have to shop around.

A new lender may insist on taking on the existing loan, which means paying out the existing lender. If this happens to be a fixed-rate loan, early termination may result in you having to pay break costs.

More recently, specialist fintech lenders have entered the bridging loan space, sensing a bit of a gap in the market, particularly for shorter-term bridging loans and faster approval times.

For example, bridgit.com.au (formerly TechLend) offers loans from $250,000 to $4 million covering up to 75% of the value of your properties for up to six months.

It also offers no repayments till maturity and 24-hour processing of applications, but with a set-up fee from 1.65% and interest rates from 6.49% (6.67% comparison rate) it's not the cheapest option.

Auswide's Home Loan Plus was the cheapest interest-only bridging loan on the ratecity.com.au website at the time of writing.

It offers up to 80% of the value of your properties at an interest rate of 6.26% (6.41% comparison rate). And if you shop around, you may well get a better deal than this, especially if you have 50% or more equity in your current property and an impeccable track record with your lender.

How the loan works 

The total amount you borrow under a bridging loan is known as the "peak debt". It includes the loan balance on your existing home, the purchase price of the new home and any purchase costs, such as stamp duty and legal and lender's fees.

The minimum repayments on a bridging loan will generally be calculated on an interest-only basis, and in some cases this interest may be capitalised until the existing home is sold - that is, accrued and added to the peak debt.

Once you sell your first property, the net proceeds of the sale - sale price minus any sale costs - are used to reduce the peak debt. The remaining debt then becomes the "end debt", which is repaid as a standard mortgage.

An example on the broker site mortgagechoice.com.au explains it well. If you have an existing property with a loan balance of $200,000 and the funds required for the new property are $500,000, you may be able to borrow up to $700,000, your "peak debt".

You now have a short-term debt of $700,000, on which interest is payable, while you wait for the sale of your existing property.

You may be able to capitalise the interest that accrues on the peak debt, if your lender offers this feature, meaning your debt will continue to increase until you either start making repayments, or the sale of your existing property is completed.

The Mortgage Choice example assumes you've been paying interest and your peak debt remains at $700,000.

You sell your property and the net proceeds of $400,000 are put towards your peak debt, leaving you an end debt of $300,000. From this point, you're on a standard mortgage product with regular repayments.

Why you would want one

The two key reasons for considering a bridging loan, according to Mortgage Choice, are:

1. Interest capitalisation 

If your servicing capacity is not quite enough to cover the repayments on both properties, a bridging loan with an interest capitalisation feature may be a suitable solution, to allow you some financial breathing space while you wait for the sale of your existing property.

2. 100% loan on the new property 

A bridging loan can allow you to borrow up to 100% of the purchase price of your new property, plus the associated costs. This is particularly useful if you've purchased a property that is outside your current borrowing capacity but which will become affordable once you've sold your existing property.

But, of course, the risks are substantial, especially if you allow your interest to capitalise. This means you will be paying interest on interest.

You could mitigate this by making some repayments, so look for a lender that allows this.

The other big risk is you do not achieve the price you need for the property you're selling. In the worst-case scenario, your lender may step in and you could lose your home if you're not able to repay the loan by the due date.

In most instances, if you don't sell your existing home within the bridging period, your lenders will charge a higher interest rate.

Many will also require you to start making principal and interest repayments on the peak debt to service both loans. This can cause financial stress.

Who would be eligible

1. Home equity

To assess how much you can borrow, lenders will look at how much equity you have in your existing home. Generally, the more equity you have, the more you'll be able to borrow.

2. End debt 

Many lenders offer bridging finance on the condition there will be an end debt. If this is not the case, such as in downsizing, the fees associated with your bridging loan may be higher.

3. Maximum end debt 

This cannot be higher than your new property's value. If it's more than 80% of the value of your new property, you may be liable for lenders mortgage insurance (LMI).

4. Sale contract

Some lenders require evidence that your existing property has been sold - for example, a sales contract with a long settlement period - as a pre-requisite for approval.

Upgrading from an apartment to a house

Jim and Nancy live in a city apartment, with a mortgage balance of $300,000, which they intend to sell to buy a new home, according to a hypothetical example on the homelaonexperts.com.au website.

But before they're able to sell the apartment, they see a well-priced house in an ideal location. They don't want to miss out, so they apply for a bridging loan and are approved, during which the couple's existing $300,000 loan becomes the bridging loan, with a maximum loan term 
of 12 months.

For the new house, the couple are approved for a $600,000 home loan, meaning they have a $900,000 combined debt (the peak debt). During the bridging period, the couple make interest-only repayments.

They sell their apartment after six months for $400,000 and use $300,000 to clear their initial mortgage balance on the property. This leaves them with $100,000, which they decide to put towards reducing the mortgage on their new property, down to $500,000.

But what if the alternative happens and 12 months later the apartment is not sold? The bank steps in to assist with the sale of the couple's property for the best offer of $270,000, but the proceeds from the sale are not enough to pay off the apartment home loan.

So, the shortfall of $30,000 is added to the new home loan, subject to approval. This increases the home loan balance to $630,000.

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