Bridging Loans: How Does it Work?

If you’re a current homeowner looking to move to a new home but haven’t concluded the sale on the house you’re still in, you might want to consider bridging loans. What is a bridging loan and when is the right time to use them? How do you qualify and apply for such a loan? This article will help you understand what this loan is and all that comes with it.

What is a Bridging Loan?

In a nutshell, bridging loans, which are sometimes called bridging finance, are a type of short-term financing designed to cover the gap between buying a new property and selling an existing one. This temporary loan allows you to finance the purchase of a new property even though you’re still paying off your existing mortgage or waiting for the house to be sold. It creates a financial “bridge,” and is particularly valuable when you need to act quickly in a competitive real estate market.

When Can You Use Bridging Loans?

A bridging loan is most effective when you need to purchase a new property quickly but haven’t yet sold your current home to unlock the cash needed for settlement. It’s instrumental in fast-moving real estate markets where you might risk losing your desired property if you wait until your existing home sells.

Bridging loans provide flexibility by allowing you to secure the new property while giving you extra time to prepare your current property for sale. This can potentially help you achieve a better sale price. You should note, however, that because these loans come with shorter terms and are secured quicker than regular loans, they tend to have higher interest rates. This is why it’s essential to have a clear plan for selling your existing property to repay the loan without incurring excessive costs.

How Do Bridging Loans Work?

So, how does a bridging loan work? These come with a slightly different process as opposed to regular home loan processes. Bridging loans are usually structured with a term of six to twelve months. They can be categorised as either “closed” or “open” loans. Closed bridging loans have a fixed deadline by which the existing property must be sold. An open bridging loan, on the other hand, provides more flexibility but usually comes with even higher interest rates.

The loan amount is determined by the “peak debt,” which includes the balance of your existing mortgage and the cost of the new property. Once your existing property is sold, the proceeds are used to reduce the peak debt, leaving you with the “end debt.” This end debt is then converted into a regular home loan for the new property.

During the bridging period, you may be required to make payments on both your existing mortgage and the bridging loan. There are some lenders though that allow interest to be capitalised, meaning it is added to the loan balance rather than requiring immediate payment.

Bridging loans offer several advantages. These include the following:

• Immediate Purchase – They allow you to buy a new property right away without waiting to sell your current home.
• Avoiding Temporary Accommodation – By bridging the gap, you can move directly into your new home without needing temporary housing.

However, there are also significant risks involved. These include:

• Higher Costs – Bridging loans often come with higher interest rates and additional fees.
• Pressure to Sell – With a set loan term, you may feel pressured to sell your existing property quickly, potentially at a lower price than desired.

Eligibility and Application Process

To qualify for a bridging loan, lenders typically evaluate your equity in the existing property. They also evaluate your income and your ability to service both the bridging loan and your current mortgage. The application process involves providing detailed financial information that includes the value of your current home and the purchase price of the new one. Some lenders may also require a clear plan for repaying the bridging loan. This often necessitates proof of a pending sale for the existing property.

Are Bridging Loans the Answer to Your Situation?

Bridging loans can be an effective solution for those needing to transition quickly from one property to another. However, to reiterate, they do come with higher costs and risks. This is why it’s essential to carefully consider whether this type of finance is appropriate for your situation. Consulting with a mortgage broker, like the experts in our team, can help determine if a bridging loan is the best option for your needs.

By helping you understand how such a loan works and weighing the pros and cons, our team here at Professional Lending Solutions can help you make an informed decision that aligns with your financial goals. Chat with us today to see how we can help you.