First of all, what does bridging the gap mean? Well, in short, a bridge loan (also referred to as gap financing) is a short-term loan that assists you with the financing of a home loan during the period that it’s not yet available to you.
Let’s say you’ve found your dream home and need to apply for a home loan, but your current home loan can’t be settled until you sell it, or perhaps you are building your dream home now, which requires a home loan and you still need to live in your current home while this happens, that it when bridge loans are there to assist you.
Basically, your loan company will take security over both the properties in concern and will finance both until the sale goes through on the original home or the build is complete in your new home. These loans are usually up to a year in length, so it literally is there just to “bridge the gap”.
So how does it all work?
When you apply for a bridging loan, the debt that you still owe on your current home is added to the cost of your new home. You repay the interest only for the bridging loan period and the amount left over is called the principal amount. Interest is compounded monthly at the standard variable rate and it’s added to your balance that continues on your mortgage loan on the new home once your existing home has been sold.
Interest can be a problem of course, when considering a bridging loan, so be sure to first have at least 50% of your current home’s value in the form of equity. This will just safeguard you from paying a massive unforeseen amount of interest. Don’t forget this is assistance, and if it can be avoided, it always should be, because essentially what you’re doing is paying off interest on two properties, so getting your existing property sold and out of the way is a major priority!
Are there benefits to this?
Well, I think an obvious one is that you’re receiving financial aid during a very stressful period which you didn’t have access to yourself. It alleviates the undesired pressure of matching up settlement dates, essentially allowing you to sell your home without the fear of losing your potential new home. It also gives you a place to live – i.e. your current home – during a building period for a new home. As with everything, there was a demand for bridge financing where these scenarios were concerned, so lenders came up with a solution to the consumers in need!
So, what are the risks if any?
The major risk is most likely overestimating the sale value of your existing home. You might find yourself in a sticky situation, not being able to afford the repayments if your home sells for less than expected. Also, if your existing home is not as much of a desirable as you had once thought it was, and no one even wants to buy it, you could end up taking a lot longer with it on the market and the bridging loan period would need to be extended, attracting higher interest rates. That’s certainly not the scenario you’re going for, although one you should be prepared for, or at least understands the recourse of this unfortunate situation.
Understand what you’re getting into
If you find yourself in either of the scenarios that call for a bridging loan, be sure to do some homework first, and so via the following guideline questions:
- What period of time will you require the financing for?
- Is property sales highest in your area and what are their turnaround times for a sale?
- Is your current home ready to go for sale?
- Are you buying an existing property or will you be building?
- Can you afford the repay the loan amounts monthly?
Lastly, what are the differences between “bridging the gap” and traditional loans?
Due to the need for a bridging loan being required during a stressful and urgent time, bridge loans tend to be far more convenient in terms of turnaround time of the application in comparison to traditional loans. Also, when it comes to funding, the loan approval doesn’t go through such a magnified process as traditional loans undergo, this is largely due to the fact that it’s a less risky loan for the lender. Why less risky you ask? In exchange for the convenience they have measures in place to ensure this, i.e. shorter terms (1 year) and higher interest rates. This doesn’t impact the choice when borrowers have explained these terms, because, at the end of the day, they wouldn’t be asking for it in the first place if they didn’t absolutely need it!