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How Does Bridging Finance Work?

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Do you often hear ‘bridging finance’ in financial conversations and wonder exactly how it works? Here’s your comprehensive guide to understanding this form of financing, making it easier for everyone, whether you’re new to finance or already a pro. Picture this: Your dream home just came up on the market, but your current house is not yet up for sale. Could bridging finance be the solution? Read on to find out.

Demystifying Bridging Finance

In the simplest terms, bridging finance is a short-term loan that helps you purchase and settle a new property even before you’ve sold your current one. It’s like having a financial safety net that ensures a smooth transition between your current and future homes. Bridging finance helps fund the full purchase price of the new property, usually covering all closing costs, including stamp duty and legal fees, and enables you to hold onto your current property, ideally to sell within six months.

The lender charges interest on this bridging loan, which accumulates and is added to your loan balance each month until you clear it with the sale proceeds of your existing property.

An Illustrative Example

Imagine you currently own a property worth $1.0m, and you owe $500k on your mortgage. You’ve just spotted your dream home for $1.5m on the market. The purchase price could be funded with a new loan of $1.6m (including costs like stamp duty). At this point, you’d owe a total of $2.1m. This is akin to standing on two stepping stones in a river, with one foot on the existing home and the other on the new purchase. While bridging the gap, the accruing interest can quickly mount up, although you don’t need to make monthly repayments on the bridging component.

Advantages and Drawbacks of Bridging Finance

The Upsides

  1. Convenient Timing: Bridging finance allows you the luxury of time, so you can purchase your next home at your leisure without having to rush the sale of your current property.
  2. Financial Resilience: Bridging finance provides temporary financial resilience that can be advantageous when a great opportunity arises in the real estate market but immediate funds are lacking.
  3. Interest Capitalisation: The interest on bridging loans is typically capitalised, meaning you don’t need to make repayments during the bridging period. This can provide a financial breather.

The Downsides

  1. Market Volatility: The biggest risk of bridging finance is the uncertainty of selling your current property within the expected timeframe or at your desired price. A volatile market can compel you to accept a lower price than anticipated.
  2. Higher Interest Rates: Bridging loans often carry higher interest rates than standard home loans, leading to significant costs if the bridging period extends for too long. While you’re not making monthly repayments, the accruing interest is added to your loan balance.
  3. Financial Stress: If the sale of your current property is delayed, the accruing interest combined with the maintenance costs of two properties can lead to financial stress.
  4. Complexity: Bridging finance can get complicated, with many factors to consider including timing the sale of your old property, managing the purchase of the new one, and juggling the financial obligations of two mortgages.

Pro Tip: Have a Clear Understanding of Your Financial Capabilities Before committing to bridging finance, it’s essential to understand your financial capabilities and the implications of carrying two loans. Always consider the worst-case scenario and ensure you have contingency plans in place.

Conclusion

Bridging finance can be a valuable asset as you navigate your journey towards home ownership. However, it’s essential to undertake a comprehensive assessment of all relevant factors and seek expert advice before moving forward. If you have any more questions or need further assistance to understand how bridging finance could be tailored to your circumstances, don’t hesitate to reach out to the team at Unconditional Finance. Our Sydney-based mortgage professionals are here to guide you every step of the way.

Frequently Asked Questions

Is bridging finance suitable for everyone?

While bridging finance can provide an excellent solution for some, it may not be suitable for everyone. Its appropriateness largely depends on individual financial circumstances and market conditions. It’s always wise to consult a mortgage professional to determine if it’s the right move for you.

What are the potential risks of bridging finance?

Bridging finance comes with potential risks, including market volatility, timing constraints, and the complexity of managing two mortgages. It’s crucial to be aware of these and plan accordingly. A mortgage professional can guide you through these risks to help you make a well-informed decision.