Have you heard of the term bridging finance? What exactly is it – and do you need it?
What is bridging finance?
Bridging finance, or a bridging loan, is a short-term loan that is usually arranged ahead of a longer-term financial solution – commonly used to finance the purchase of a new property before selling your current home.
For example, if you’re already a homeowner and you want to upgrade or move, chances are you’ll need to use the proceeds from the sale of your current home to pay for the cost of the new one. This can be a problem if you want to buy before you sell.
A bridging loan ‘bridges the gap’ that exists in this situation – it provides the funds when you essentially own two homes while you wait for the first one to sell.
What are the terms of a bridging loan?
Bridging loans come in all shapes and sizes. However, there are some standard features.
Firstly, bridging loans are short-term by nature. The length of a bridging loan may vary between a couple of weeks and a couple of years.
Secondly, given the short time frame, interest rates will traditionally be higher than those of your standard long-term loan. Nonetheless, these will also vary based on your financial situation, as well as other loan and market conditions.
How do you make repayments on a bridging loan?
The repayment structure can be catered to the needs of the borrower.
There are three main ways to structure your repayments, which include the following:
- Capitalising interest
This could be a good solution for those with existing assets who may be looking to sell a property and downsize. If you’re selling your property, you don’t need to make monthly repayments. Under this structure, you make no payments at all. Then, at the end of the term, you make all the repayments, plus the capital you’ve borrowed.
- Paying monthly in arrears
If you’re selling your house and taking out a bridging loan until you sell your current one, it might require that you service the loan, which means making monthly payments.
- Pre-paid interest
In some circumstances, you may want to opt for pre-paying the interest.
For instance, you may need to borrow $500,000 to buy a house, you might want to borrow the interest as well. What this means is you are borrowing the principal amount required for your purchase as well as the monthly interest component. The bridging financier holds onto this and then makes a payment for you each month. This particular style of payment works most effectively when your exit strategy from your bridging finance company to a mainstream bank is to refinance.
There are pros and cons to bridging finance, and it’s advised you always seek professional advice that takes into account your financial situation.