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The Pros and Cons of a Bridging Loan

The Pros and Cons of a Bridging Loan

If you want to purchase another home before selling your current residence, you can talk to your lender or mortgage broker about securing a bridge loan – also called a bridging loan – to cover the costs of the new purchase until you receive the funds from the sale of your first house.

Like any loan, a bridging loan has positive and negative aspects, so it is important to weigh up the pros and cons before deciding whether this is the right option for you.

Conditions of a bridge loan

While different lenders will have varying rules, there are some standard features to bridge loan requirements. In order to qualify for a bridge loan, you should have more than 50% in equity, and you must have documentation proving your ability to financially manage the loan. A bridging loan is usually short term, between 6 months and 12 months, depending on your lender and the property you are buying.

You can generally borrow up to 80% of your peak debt to cover the purchase price of your new property along with enough to cover the expenses of your current mortgage.

 Benefits of a bridge loan

The number one benefit of a bridging loan is that you can find the right house in your own time without disrupting your living arrangements too much.  Some home buyers will rent for six months to give them time to find the right property after the sale of their first home. This builds up additional costs through rent, especially if you are ready to purchase before your lease runs out. Other home buyers will rush into a purchase to ensure they have somewhere to live within the tight timeframe between finding a buyer and the settlement date. With a bridging loan, you have the leisure to find the right property and snap it up straight away, move house once, and then focus on selling your previous home.

You also have the advantage of holding out for the right price on your former home. Without the rush and stress of matching up settlement dates, you will not need to settle for a lower price, because you can wait for another buyer.

From a financial perspective, you can continue making payments throughout the term of the bridging loan, reducing your principle and interest during this timeframe.

Disadvantages of a bridge loan

A bridge loan comes with additional expenses that you need to calculate in advance to ensure this is the right option for you. Firstly, your lender will expect you to pay for a valuation of both properties – the existing property and your intended purchase.

Interest is usually higher on a bridging loan than a regular home loan, due to the fact that the bridging loan is temporary finance. Interest is usually compounded monthly, and the interest rate will be higher if you do not sell your property within the bridging period. Your lender may also expect you to make payments on both principle and interest, which can increase your financial stress.

Is a bridging loan right for you?

In order to work out whether a bridge loan is the right option for your circumstances, you will need to calculate all the variables – will the additional interest payments cost you more than rent? How will you manage if your first home doesn’t sell within the timeframe of the loan? Talk to your mortgage broker to discuss all the various costs so you can decide whether a bridging loan is the right decision for you.

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