What is bridging finance and how does it work?

Housing Market Written by Squirrel, Dec 9 2019

Anyone that’s moved properties knows just how exhausting it can be. Between getting your place on the market, heading to open homes and making offers, both buying and selling can be overwhelming in their own right. Then consider the task of matching up settlement days and potentially losing your perfect property, all the while trying to sell your existing home... it’s enough to make anyone break out in a sweat.

We see clients all the time who are juggling both, and this is where bridging finance comes in.

So, what is bridging finance?

In a nutshell, it’s a short-term home loan. The purpose of bridging finance is to provide homeowners with a loan that will allow them to purchase a new property before selling their existing one, making the moving process easier and more feasible.

There are two different types of bridging loans:

Open bridging loans

If you require bridging finance before finalising the sale of your property, you will be looking at getting an open-ended bridging loan. Buyers looking to borrow open bridging loans are seen as a greater risk to lenders, because they’re generally unable to provide a definitive date of when their property will be sold by, and therefore when they will be able to repay the entire loan. This means that the process of securing an open bridging loan can be more extensive and often require more equity in your property.

Closed bridging loans

A closed bridging loan differs as it is based on a predetermined date by which your property will be sold. Closed bridging finance is intended for home sellers that have already finalised their sale terms and therefore is generally not as risky for lenders, often requiring less equity.

How much does a bridging loan cost?

Taking on a bridging loan is an added cost on top of the existing mortgage you’re paying, so banks will look closely at your affordability.

Bridging loans are set on the floating rate that’s advertised at the time which is higher than the lower fixed rates, but they can be on interest-only terms so that you don’t have to pay the principal during the bridging period. Once the existing property sells and the mortgage is repaid, the leftover balance is fixed.

Why would you get a bridging loan?

The main benefit of a bridging loan is to alleviate stress during the moving process. The temporary finance gives you the freedom to find a new home without having to sacrifice your requirements in a property.

It also means you don’t need to worry about matching up settlement dates, reducing the pressure to sell fast and for less than you’d hoped.

Should you buy or sell first?

So, you’ve decided that it’s time to make the move. But what next? Should you focus on putting your property on the market first? Or is it best to jump straight into home viewings and wait until you’ve found a new house before you think about selling?

Unfortunately, there’s no simple answer and this depends wholly on your personal circumstances. Eligibility for bridging finance, urgency required for moving and where you are moving to all play factors in choosing which approach is best for you. To help you make the decision, we’ve broken down the benefits and risks of both perspectives.

Buying first

When it comes to buying first, one of the biggest benefits is that you won’t be in as much of a rush and can take your time to find your perfect property. If you are able to keep an eye on the market and allow yourself a comfortable length time for house hunting, you’re more likely to find a property that meets all of your needs.

On the other hand, if you buy a property before selling, you are opening yourself up to financial risk. If you have an existing mortgage and require bridging finance or a loan to purchase your new property, you would be paying interest on two loans at the same time. There is also the chance that your existing home may not sell immediately or may sell for less than expected, potentially putting you in greater debt.

Selling first

Selling your home before buying a new one means that you know exactly where you stand financially. As you will already know how much your existing home has been sold for, you will have a better idea of what you can and can’t afford, leaving less room for nasty surprises down the line. That said, selling first does put time pressure on the house-hunting process.

Depending on current trends and the state of the property market, it could be months before a property that meets your requirements in your price range and preferred location is available. This means that those who sell first are sometimes required to make sacrifices when purchasing their new home. It’s worth noting that even if you did find your dream property immediately, the housing demand throughout New Zealand is rapidly growing and there’s no guarantee that your offer will be accepted.

So, how should you make your decision? The best way to reduce stress and risk is to be as proactive as possible. If you can, give yourself plenty of time to both look for a new property and sell your existing home. Do your research, put back up plans into place and try to avoid making rushed decisions. It’s not always feasible, but it certainly helps!

What to consider before taking bridging finance

Like with any type of loan or major financial decision, there are considerations that need to be made before committing to bridging finance. We’ve compiled a list of the main factors that you should think about prior to taking out a bridging loan.

  1. Do you already have an unconditional offer on your existing home?
    The chances are that you will be in a much more comfortable position to commit to bridging finance if you already have an unconditional offer on your current property. This means that you will know how much money you can borrow and when you can repay the loan, reducing your personal risk.

  2. What is the average time in the property market in your location?
    It’s always worth doing your research and gauging the status of the property market in your particular location. Is it likely that your home will sell within the agreed bridging period? What are you basing your expectations on? We keep our finger on the pulse and have tools to check out recent sales in any area, so it could be worth having a chat.

  3. What will happen if your home sells for less than expected?
    We hope that it doesn’t happen, but there’s always a chance that your home might sell for less than you’d hoped. It’s important to consider this possibility and get a strategy in place to ensure you aren’t suddenly burdened with more debt than you can afford.

  4. Do you have a plan in place if your home takes longer to sell than expected?
    When you take out bridging finance, you commit to a predetermined bridging period. If your home takes longer to sell than you expected, you might not be able to meet the terms of your loan. Carefully consider your terms and try to put together a backup plan, just in case everything doesn’t go to plan.

  5. Can you afford to pay for two loans at the same time?
    When you apply for bridging finance, you need to factor in the current payment of your existing mortgage, as well as the potential repayments on the bridging loan.

  6. Are you eligible for a bridging loan?
    Whether or not a lender will provide you with bridging finance depends on a range of factors. These may include how much equity you have in your existing home and the volume of your current savings. A good savings buffer of at least $30,000 can provide assurance to your lender that you will be able to cover mortgage repayments on the bridging loan for at least a year if your house doesn’t sell in the expected timeframe. A great first step is to get in touch with us so we can look into whether you’d be eligible for bridging finance (and which bank might be best for you, as they all have slightly different criteria).

Let’s talk

We know first-hand how stressful it can be to move properties and juggle finances. We’re here to make the whole process easier, so if you have any questions about bridging finance or what loans you might be eligible for, get in touch with our friendly team.

We can help. Have a chat to one of our advisers.