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Marty McDonald - Monday, November 02, 2015
Many home buyers encounter an unpleasant scenario where their dream home is found but their current property has not been put on the market yet. Or it is on the market but buying now would mean they have to accept a low price for their current home so that they can marry up the two settlement dates not to mention it puts them in a stressful position. While many may see limited options in this situation, utilising a bringing loan can allow the home buyer to act quickly and confidently, purchasing their perfect house before the current one is sold and in most cases capitalising on the situation. A bridging loan allows home buyers to upgrade properties in a seamless manner. You won’t need to co-ordinate settlement dates or find temporary housing and will be ready to buy from the moment you enter the highly competitive housing market.
How does it work?
A bridging loan or bridging finance is when you retain the existing loan on your current home plus you borrow the funds required to settle the property being purchased. Mortgages are held by the same lender over both properties. The lender then allows interest to accrue on the bridging portion of the loan for up to 6 months giving the borrower time to sell their first property. The total amount borrowed plus an allowance for interest is known as the Peak Debt and once the original property has been sold, the net proceeds are used to reduce the overall loan amount. The remaining debt is called the end debt and is then converted to a regular mortgage product. Different lenders work things out quite differently in this space but the usual rule is the borrower only has to be able to show that they can service the end debt not the peak debt. You would usually have the opportunity to make repayments on the existing loan or proposed end loan while the bridging portion has the interest capitalised onto the loan until the existing property is sold.
As an example say you may have a remaining $400,000 loan on a property valued at $900,000. You’ve only just placed your house on the market but have found your dream family home valued at $1,200,000. With a limited window for purchase you decide to utilise a bridging loan. This gives you an initial bridging loan debt of $1,260,000 (new property loan $1,200,000 + funds for stamp duty $60,000 ) while you still have your existing home loan of $400,000. Assuming it then takes only 2 months to sell your home and that you continued to make repayments on your $400,000 home loan the interest accrued on the bridging portion would be approximately $12,000. This is the cost of doing the transaction this way but in a rising market you may actually come out ahead.
When you sell you elect to use the entire proceeds to pay down your peak debt ($400,000 + $1,260,000 + $12,000 = $1,672,000). Assuming a 2.5% selling cost you net $882,000. Therefore your end debt becomes $790,000.
Let's also check the loan to value ratios (LVR's) in our scenario as the peak and end debt generally need to be under 70% (80% with a few lenders). Exceptions can apply.
- * Peak debt / Values of both properties = $1,672,000 / $2,100,000 = 79.62%
- * End debt / Value of new property = $790,000 / $1,200,000 = 65.83%
So this scenario would only be available with a few lenders that we know of.
Why use a broker
Every lender has a different policy and different ways of assessing bridging loans. It really is quite diverse. Some lenders require the borrowers to be able to service the peak debts interest (CBA does this) while others don't offer true bridging loans at all and look at the entire peak debt (ANZ). A true bridging loan is one where the serviceability is assessed only on the end debt.
As a rule of thumb we suggest you will need at least 50% equity in your existing home before considering a bridging loan to facilitate your home upgrade. A broker will also help to evaluate whether this is the best option, given your circumstance. Often we can work out a way to do a "quasi" bridging loan that may be more cost effective.
Give me a call to discuss your bridging options (before you have bought!)
About the Author:
Marty McDonald is principal of mortgage broker “Mortgage Experts”. Marty specialises in assisting active property investors with loan structuring advice and implementation as well as helping credit worthy borrowers with slightly outside the box income and employment situations. Find Marty on Facebook