Owning a home may be straightforward for most Australians, but for some, moving into a new home could coincide with still paying off the loan in the old home.

This is when bridging loans come into play. Bridging loans, also known as bridge financing, serve as a temporary solution that provides quick access to capital while in the process of selling your old home and purchasing a new one.

While a bridging loan sounds like a dream strategy, it does come with certain considerations that could potentially increase your debt repayments in the long run.

Let’s look at what it means to bridge loans, what instances it could apply, and what are the potential pros and drawbacks associated with bridging loans.

What is a bridging loan?

A bridging loan in Australia is a short-term solution that literally ‘bridges’ a home buyer’s financing. The best scenario for a bridging loan is when a client wants to buy a home, but the funds from the sale of the old home haven’t yet reached their bank account.

Bridging loans provides funds for buyers who need to move quickly to secure a new property. It’s usually a short-term loan that has around 6 to 12 months duration. A bridging loan is akin to a line of credit that you take out to support the cost of transitioning from an old property to a new one.

With this financing, you can avoid the stress of matching the settlement date of your old home to your move onto the new property. These loans “bridge” the financial gap by providing borrowers with a temporary infusion of cash until more permanent financing options can be arranged.

You get a brand new home and at the same time buy some time to sell your previous property.

How does a bridging loan work?

A bridging loan is short-term finance where lenders use both properties as security. The bank calculates the size of your loan by combining the remaining mortgage debt on the old home to the value of your new home. These values combined are called the “peak debt”.

The lender then subtracts the likely sale price of your old property and its associated costs.

What is left is the “end debt” or “ongoing balance,” which is essentially the principal amount of your bridging financing.

Crunching the numbers will also include a “fire sale buffer.” This refers to the possibility that the borrower might sell the property for a lower price than initially estimated. The buffer would range from 10% to 15% of the old home’s value.  

Lenders often allow borrowers to loan up to 80% of the peak debt.

They offer interest-only repayments on the peak debt during the in-between period of selling the existing home and moving into the new property. In short, you only contend with paying off the principal and interest (P&I) on the existing mortgage, rather than getting overwhelmed with holding two home loan P & I repayments.

How do I make repayments on the bridging loan?

Taking on two mortgage payments would very likely be too much for the average Aussie homebuyer.

Fortunately, most bridging loan lenders offer interest-only repayments, which is more affordable than paying two sets of debts simultaneously.

There are also options deferring the repayments during the bridging period by capitalizing the interest repayments on top of the loan balance, but keep in mind that later you will be charged additional interest.

Bridging loan clients can also make voluntary principal payments if they choose to, which could significantly reduce the total interest on the overall loan. And once you are able to sell the old property, the proceeds are used to pay off the existing debt, after which you can close the bridging loan and then focus on the standard mortgage repayments for the new home.

Bridging loan terms

Since bridging loans are short-term in nature, it is unlikely that lenders would offer a term longer than 12 months.

If, unfortunately, you are unable to sell the property within the set period, the lender may assist in selling the property but at a lower sale price than estimated when taking out the loan. So the proceeds may not be enough to cover the entire bridging loan. Any remaining debt would then carry over to the new home loan.

Here are loan terms specific to a bridging loan:

• Requires a minimum amount of equity to apply (20%)
• Existing home must be sold within 6 to 12 months
• Typically won’t have a redraw facility during the bridging loan term
• Not accessible for construction loans, company purchase, or strata title

When should I use a bridging loan?

Bridging loans are commonly used in property-related transactions. Here are key advantages to bridging your home loan:

Cover auction purchases – If you found your new home at an auction sale, you would want to pay as quickly as possible to avoid losing out on the property. Auction purchases require quick payment, but this is not always feasible for standard home loans. A bridging loan lets you secure the new home and give time to arrange for the sale of the old property.

Avoid paying two home loans – The main draw for bridging finance is that it allows you to purchase a new home without taking out another full home loan. It’s perfect for time-sensitive opportunities without overwhelming you with mortgage repayments.

Interest-only payments – During the bridging loan term, you don’t need to make P&I repayments, as the lender could offer interest-only at this time.

Move-in to the new home – If you prefer moving into a new home right away, or are building a new property but prefer to have extra funds without renting a new place, a bridging loan enables you to avoid renting between the time it takes to sell the existing home.

What are the drawbacks of a bridging loan?

Not every home buyer would benefit from a bridging loan. Consider these drawbacks:

Higher interest rates – Bridging loans generally have higher interest rates compared to standard home loans, given the short-term nature and quick approval process. Borrowers should carefully consider the cost implications and ensure they have a viable exit strategy for repaying the loan.

Financial risk – As with any loan, there is an inherent financial risk involved, but even more so with bridging finance. To be able to pay off the loan, you must sell the existing home within a year. Failure to do so means you will sell for less than the estimated value, and come up short on the proceeds.

Break costs – If your current lender does not offer a bridging loan, you will have to switch to another lender. This would entail additional costs for early termination fees and break costs, especially if you are on a fixed rate mortgage.

No redraw facility – Bridging loans allow early repayments, but you won’t be able to redraw if you need to do so.

Bridging loan example

A couple wishes to upgrade to a larger property for their two kids. They already have an eye on a new home but have not sold the current apartment yet, in which they have an existing $300,000 mortgage. The new home is valued at $600,000.

They took out a bridging loan at a peak debt of $900,000. After 10 months, the couple sells the apartment for $380,000, and the proceeds used to cover the remaining mortgage of $300,000. The couple are left with $80,000 net proceeds.

The couple’s peak debt of $900,000 – now less $300,000 on the property sold – the entirety of the home loan is now at $600,000. The repayment scheme would now switch to a principal and interest mortgage.

Now, this is a more ideal scenario because the property was sold right within the time frame of the bridging finance.

However, if 12 months later the apartment remains unsold, the lender could step in to facilitate the sale of the apartment. From the estimated value of $380,000 the best offer is now only $270,000. This means the proceeds from the sale are smaller and would not be enough to pay off the couple’s previous mortgage.

The shortfall of $30,000 is added to the new home loan, subject to approval. The couple would now have a mortgage balance of $630,000.

As can be seen, not all bridging loan borrowers can benefit from the arrangement. It could result in higher interest repayments if the existing property isn’t sold at an ideal price within the bridging period.

Do you need a bridging loan?

The best way to decide if a bridging loan is right for you is to consult a mortgage broker. Remember, even if you are able to purchase a new home right away, bridging loans may not necessarily be helpful in the long term.

Consider the clearance rates in your area. How long is the projected sale of your old property? Will it be within the bridging term, or would it be more likely to lower in resale value? Maybe you are in a capital city where the home would be snapped up in a few months – you don’t need to bridge the loan and accrue higher interest rates then.

When it comes to home loans, bridging finance would be more beneficial in suburbs where properties tend to stay on the market for longer.

Bridging loans could also be useful for homeowners who are building a new home but prefer not to rent another place. It gives you time to sell the existing property without having to rush and settle on a mediocre rate.

Speak to our Intellichoice mortgage specialists about your current plans to weigh your home loan options.

Darin Hindmarsh

See Full Bio