Ever wondered how to purchase a new home before you have sold your current home? You know you’ll have sufficient funds once you sell, but what do you do if settlement for your new purchase occurs before settlement for the sale of your current home?
If you have to sell first you may miss out on the property or be without a home for a period…hardly ideal is it! So let’s look at how bridging finance can help you out…
What exactly is bridging finance?
Bridging Finance is exactly what it sounds like. It is lending that bridges the gap, allowing you to purchase a new home before the sale of your existing property. It is a financial option for those who have found their new home before having sold their existing home.
How does it work?
Let’s use an example to illustrate all this:
You own a home worth $600,000 with a $100,000 loan against it and $100,000 in savings.
You then purchase a new home for $1,000,000. To fund this purchase and the cover all the stamp duty and government fees you will need around $1,060,000.
This means if you buy before you have sold your home you will need a loan of $960,000 ($1,060,000 total cost of purchase less $100,000 savings) to fund the new purchase. This lending is on top of your current $100,000 home loan so your maximum debt prior to selling is $1,060,000 (peak debt). That means that overall your lending sits at 66.25% of the value of the 2 properties (existing home $600,000 + new home $1,000,000 = $1,600,000)
Once you have sold your existing home the total debt will reduce by $500,000 ($600,000 sale price less $100,000 owing on the existing home loan) meaning your final debt is $560,000 (end debt).
The difference between the peak debt and the end debt is considerable. On top of this there are a number of variables that will greatly impact the ability of the borrowers to handle this scenario.
Apart from the financial position of the borrowers (income, commitments, living costs etc.) the next biggest factors are timing (how long will you have to carry the peak debt for?) and uncertainty (when will you sell your existing home? How long will settlement be? What price will you sell it for?)
It is timing and uncertainty that make lenders cautious about bridging finance and this caution manifests itself in a few ways;
- Some lenders won’t look at any sort of bridging finance at all; or
- There are lenders that will offer bridging finance but only if most of the uncertainty is removed from the picture.; or
- Lastly, a few lenders will offer bridging finance but deal with the uncertainty by building lots of “buffers” into the equation designed to minimise the risk to them (and you) if things don’t go as planned.
Lets look at these options in more detail:
1. Lenders who won’t offer bridging finance
There are only a few lenders that won’t do some sort of bridging loan. But if you are talking to one of these lenders you just need to move on and talk to another lender…
2. Bridging “with certainty”
The majority of banks will allow bridging finance where you can provide a signed contract for the sale of your existing property…and they will not provide bridging finance without this. In effect they do not want any uncertainty about what the final debt will be and when the peak debt will be paid down. Banks providing this sort of bridging finance will need to see the following from you:
- You can show the bank a signed contract of sale for the property you are selling so that the bank can see what funds you will receive and when, what the peak debt will be and for how long.
- The debt at no stage is more than 80% of the value of the properties being used as security for the loan
- You can establish, to the banks satisfaction, that you can afford the End Debt given your income, living expenses and ongoing commitments
The limitation of this option for borrowers is that you cannot apply for finance until you have sold your home and if you buy before you sell, you may not have sufficient time at that point to get finance approved and in place before settlement on the purchase is due.
So it is vital if you want to go this way to ensure that you have a long settlement on your purchase (90-180 days) to allow you to sell your home and then have enough time to apply for and finalise finance.
3. Bridging “with buffers”
Only a few lenders will do this due to the risks…You are asking a lender to fund a new purchase promising to pay the loan down from the proceeds of selling your existing home. What if you can’t sell your home? Or can only sell it at a price far lower that you had banked on? Or what if it takes you take 6-12 months to sell rather than 30-120 days?
Any of these variables will greatly affect your ability to afford the repayments on the peak debt in the short term and the end debt beyond that. And that could mean you end up being unable to afford the loan – which is the last thing the bank wants – regardless of how much equity there is in the properties held as security for the lending.
So lenders that are prepared to provide bridging finance before you have sold your existing home will usually do some or all of the following:
- Build into the loan the interest on the lending for the duration of the bridging period available which helps your cash flow but can reduce the effective amount you can borrow under bridging finance
- Reduce the value of your existing property by a margin of 10-15% when running calculations as to the maximum loan amount possible.
- Require you to sell (and settle on the sale of) the existing property within 6-12 months
- Generally limit lending (peak & end debt) to 80% of the property values (remembering that, given the buffering mentioned above the lending limit is in effect less)
All of this means that typically only strong scenarios become eligible for bridging finance with these lenders.
The advantage of this option is you can buy when you find the right place and do not need to wait until you have sold OR sell before you know that you have found your new home (particularly handy if you are very selective about what you are going to buy).
Not having to sell first also means that you wont have to move out of your existing home and rent while you look for a new home.
Also you don’t need to rush the selling of your property and can make the process less stressful by selling it when you’re ready after a full campaign to maximise buyers and hopefully sale price.
The downside of this option is that you at the time you buy you do not know for certain what price you will get for your existing home…and you might be in for a nasty shock if you have an over inflated view of your existing home…or if the market takes a dip before you finalise a sale.
Rates, fees and charges with Bridging Finance
There is a misconception that bridging finance is very expensive. That is generally not the case. While in some cases, lenders will charge you their Standard Variable rate for the bridging finance, in many cases you will pay the same rate on your bridging loan as you will pay on your end loan.
There are a few more fees with bridging finance – generally under $1,000 – due to there being mortgages over 2 properties and then the payout and discharge of the mortgage over the property being sold.
What else do you need to know?
Whilst Bridging Finance is not overly complex, I suggest allowing a little more time to get it organised.
Secondly, whichever bridging option you use, all the lending basically needs to be with the one lender. So that means either using your existing lender OR moving your existing loan across to the lender you wish to be with for the new home.
Thirdly, whilst this is not strictly a bridging finance issue, if you are going to buy before you sell make sure you have the funds available to pay the deposit for the purchase. If you do not have savings that you can use, you might need to arrange an increase to your existing home loan to release funds you can use for this purpose.
Be prepared. Speak to us.
The most important aspect is to make sure you’re well prepared and have a plan in place. Speaking to a us before embarking on your selling/purchasing plans is crucial as we can advise you whether bridging finance is an option for you and can also help you understand how it works.