Buying a new home and selling your current property can be tricky, especially if there is a gap between the sale and purchase of the property and you have nowhere to live in the meantime. While you could try and match up settlement dates on both the new home purchase and the sale of the current property, the uncertainty of property sales can make this a risky option.
A bridging loan may be a suitable option to consider. These loans are specifically designed for people who have bought a new home before they sell their current home. When you take out a bridging loan, your lender will finance the purchase of your new property with an additional loan on top of your existing one. Generally, these loans have short terms of six to 12 months, during which you will need to sell your existing property.
On a bridging loan, you will be charged interest on both loans, but you will usually only be required to make principal repayments on the new mortgage. This will help you keep your costs down while you try to sell your old property. To calculate the total amount of the loan, your lender will add the price of your new property to the mortgage amount on your existing property. This number is known as peak debt. Most lenders will require a valuation of your current home to verify its value and get an idea of what its sale price might be.
Bridging loans can be quite complex and difficult to understand, so here are two scenarios that may help you determine whether a bridging loan is suitable for you.
Scenario 1 – Jack and Jude
Jack and Jude live in a small one-bedroom unit and they have decided they need more space to expand their family. They have put their unit on the market and started hunting for another property. They find the perfect home almost immediately and decide to make an offer as soon as possible so that they do not miss out. They speak to their mortgage broker, who recommends a bridging loan, and they make a swift purchase.
Jack and Jude are approved for a bridging loan of $500,000 to cover the purchase of the new property. Their existing mortgage is $200,000, making their peak debt or total loan amount $700,000 ($200,000 + $500,000). Jack and Jude make principal and interest repayments on the new loan of $500,000 and pay interest only on their $200,000 existing mortgage.
A month into the future, the couple receive an offer of $350,000 for their old one-bedroom unit, which they promptly accept. Using the proceeds of the sale, they can pay off their existing mortgage amount of $200,000. The additional $150,000 remaining from the sale is then used to reduce the size of their new mortgage from $500,000 to $350,000.
Scenario 2 – Bec and Ben
Bec and Ben own a home that has increased in value over the last five years. The value increase has given them more equity in the home, and when they sell, they expect to make a large profit. They are looking to buy a new home, but they do not have a deposit saved to purchase it. After speaking to their lender, they find out that a bridging loan will allow them to finance 100 per cent of the purchase price of the new home.
Bec and Ben are approved for a bridging loan of $750,000 to cover the purchase of the new property. Their existing mortgage is $250,000, setting their peak debt or total loan amount at $1,000,000 ($750,000 + $250,000). Their existing home sells quickly for $500,000. They use the proceeds of the sale to pay off their existing mortgage amount, reducing their total debt to $500,000.
While a bridging loan worked seamlessly in these two scenarios, they may not be the right fit for everyone. Make sure you speak to a financial advisor or your lender before you decide. It is also important to ensure you can afford repayments before opting for a bridging loan.
About Helen Baker
Helen Baker is a financial adviser, author, speaker, and spokesperson for online finance information platform Money.com.au. Helen has a passion for empowering Aussies to find financial freedom through strategic planning and goals-based financial advice. She has worked as a qualified financial adviser since 2009 and was a finalist in both the Financial Planner/Advisor of the Year and Women’s Community Program of the Year categories in 2017 as well. For more information, visit Money.com.au.