Buying the home of their dreams will no doubt be top of many Aussie new year’s resolutions for 2024. Yet with house prices continuing to rise across the country, is this really achievable in the short term?
One way of capturing that place you’ve had your eye on for months and is now suddenly on the market can be exploring the concept of a bridging loan, which is a short-term loan that can help you finance a new house purchase while you sell your current property.
Bridging loans are not a new concept, but they are becoming an increasingly popular option for owner-occupiers and property investors across the globe right now, with rising property prices creating a FOMO culture once again after the Covid years.
Recent research from the UK indicates demand for bridging loans to fund investment purchases surged to 22% in the June quarter , and here in Australia we are noticing an increase in owner-occupiers exploring this option to fund their property dreams.
So how do bridging loans work and why the sudden uptake in demand?
Is buying first an option?
The traditional – and most risk averse – way to upgrade your property is to sell first and buy once you know what you can afford, based on the proceeds of your sale.
However, there is an alternative option. Buying first before selling your existing home can seem risky, but in some circumstances it may well be the best option.
For example, let’s say you intend to sell your current property – in this instance an apartment – to upgrade to a house. However, before you can sell this apartment, you notice a property has come on the market in an ideal location where supply is scarce and demand is high. You don’t want to miss the chance to buy this dream home, so you choose to buy now and sell later.
By using a bridging loan to finance the new purchase (and maybe using the equity in your existing apartment to make up any shortfall), you are effectively taking on two mortgages for a short period of time. Many lenders will allow you to switch to interest only payments on both these loans for a finite period to make the transaction affordable. Some will even capitalise the interest of the bridging portion, meaning no repayments are required on this component.
Once you sell your apartment, you can then pay off the bridging loan with the proceeds and close the account. The loan will then convert the remaining mortgage on their new property to principle & interest loan, enabling them to pay down the remaining balance quicker.
Bridging loans seem to be en vogue at present, and in part this is due to the rising property values. When prices are going up – which they are at present after a period of consolidation when interest rates started rising – the fear of missing out on that ideal property increases. More people jump into the market before the price of their dream home gets too high and finding the perfect place gets even harder.
Pros & Cons
Sounds too good to be true right? Well, it isn’t but as with any financial decision there are pros and cons to taking out a bridging loan. Let’s start with the potential downside.
The most obvious concern for anyone looking to use a bridging loan facility is that you will have to pay two mortgages – you’ll need to pay your original home loan and the bridging finance loan at the same time. As mentioned above, lenders will be flexible on converting the loans to interest only for this period, but you still need to be able to service them.
Another factor to consider is that a condition of any bridging loan will be that you sell your existing property within a finite period – usually between six to twelve months.
While this is a reasonable amount of time to sell – especially in the current market – there are no guarantees, and you may have to find more funds to cover the shortfall if you can’t sell in the time allowed. If the property market you are entering is at risk of collapsing, buying first can be a very risky option.
Fortunately, there are a number of upsides to buying first and selling later.
One example is avoiding moving into a rental property, which many people need to do if they decide to sell first and buy later. This can involve significant costs such multiple moving fees, as well as paying someone else’s mortgage in the meantime!
Secondly, you can potentially take advantage of a rising market by buying earlier and selling later, although this does depend on market conditions. For example, if prices are relatively stable or even rising slightly (as is the case right now), buying first could have you quids in over the long term.
Is it right for me?
Everyone’s financial circumstances are different, and using a bridging loan to help you buy before you sell won’t be financially sensible for all.
As listed above, taking out bridging finance has its risks, and you need to be truly comfortable with these. You also need to ensure its financially possible for you to manage two loans, and you’ll almost certainly need a significant amount of equity in your existing property to make the transaction viable. If this is not the case, selling first and renting for a short period while you buy may be the way to go.
Timing is also a factor in deciding whether buying first is sensible, as it is often more advantageous in a rising market. Keeping an eye on property sales in your area is a good way to assess this and buying in the same market / area you already live will also minimise your risk.
One comfort when considering these risks is that Australian consumers are relatively well protected from taking out unsuitable finance since the national credit code was amended over a decade ago.
This legislative update was part of a larger reform process that introduced a licensing regime for lenders and brokers, which includes obligations such as responsible lending and mandatory membership of the Australian Financial Complaints Authority (AFCA).
In other words, it’s much harder for unscrupulous lenders to sell you finance products that you can’t afford.
As with any financial decision, it pays to do your homework and be realistic with what your budget allows. It also pays to use a mortgage broker who has experience in sourcing and transacting bridging loans, as many brokers stay see them as over complicated. They aren’t as long as you (or your broker) understand what’s on offer and how to benefit from them.
Whatever your choice, bridging loans are becoming an important part of the Australian property finance market and it’s worth considering them if you want to be in that dream home sooner.
Loanscope have years of experienced handling bridging loan solutions for customers looking to upgrade their own home or build their property portfolio – contact us for a confidential, obligation free discussion.
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