In the dynamic world of real estate, opportunities often arise that require swift and decisive action. For many people, looking to seamlessly transition from one property to another, a bridging loan can be the financial bridge that facilitates a smooth transition. In this blog, we will explore what a bridging loan is, how it works, and delve into a real-life example to illustrate its practical application.
What is a Bridging Loa?
A bridging loan is a short-term financial solution designed to bridge the gap between the purchase of a new property first and the sale of an existing one later. It is a valuable tool for those looking to streamline the process of buying and selling real estate, allowing them to secure the funds needed to acquire a new property before selling their current one.
How does it work?
Let's take the example of Nicole and David to understand how a bridging loan works:
Nicole and David own an apartment valued at $620,000 with an existing mortgage of $180,000. They decide it's time to change to a bigger house for the growing family.
They have found their dream property priced at $860,000 and want to secure it before selling their current property.
As they haven't sold their apartment yet, they need the money to cover the purchase price and cost. It's a typical "Buy Now and Sell Later" scenario and a bridging loan solution will help them achieve it effectively.
First, let's take a look how much the loan they need:
1. The existing loan of $180,000
2. A new loan of $900,000 to cover the purchase price, stamp duty and other cost
So they need a total loan of $1,080,000. We call it the Peak Loan. The Peak loan is the maximum loan they will have after having bought the new home until the old property is sold.
Based on Nicole and David's financial position, the bank can lend them up to $660,000 as a mortgage over 30 year term. This loan is called the End Loan. This is the loan they will have after the existing apartment is sold.
The difference between the Peak Loan of $1,080,000 and the End Loan of $660,000, that is $420,000, is the Bridging Loan. This Bridging loan must be paid out when the existing apartment is sold.
Shortly after Nicole and David has bought the new home, they listed the existing apartment for sale and eventually managed to sell the apartment 3 months later and paid out the Bridging Loan of $420,000 from the sales proceeds.
Now they only have a mortgage of $660,000.
Benefits of bridging loans:
1. Speed and flexibility: Bridging loans enable swift property acquisitions, allowing borrowers to seize opportunities in a competitive market.
2. No need to wait: Borrowers can proceed with buying a new property without waiting for the sale of their current one, preventing missed opportunities and ensuring a smoother transition.
3. Unlock the equity: Bridging loans allow borrowers to leverage the equity in their existing property, providing access to larger funds.
Potential risks:
While bridging loans offer flexibility, there are potential risks involved:
1. Market Fluctuations: Property values may change during the bridging period, affecting the sale price of the existing property.
2. Sale Delays: Unexpected delays in selling the existing property may lead to increased interest costs on the bridging loan.
3. Choice of lenders: Not all the lenders offer bridging loans, borrower may face a limited selection of lenders.
4. Interest Rates: Bridging loans often have higher interest rates than traditional mortgages, impacting overall borrowing costs.
Costs involved:
1. Interest Charges: Borrowers are charged interest on the entire bridging loan amount until it is repaid.
2. Establishment Fees: Lenders may charge fees for setting up the bridging loan.
3. Valuation and Legal Fees: Costs associated with property valuation and legal processes.
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Is the bridging loan suitable for me?
Bridging loans serve as a valuable tool for individuals like Nicole and David, offering the flexibility to secure a new property before selling an existing one. However, it's crucial to carefully consider the potential risks and costs involved. Equipped with the knowledge and experience, we can help you navigate the intricacies of bridging loans and ensure a successful property transition.