All you need to know about bridging finance
THEY SAY THAT PURCHASING YOUR FIRST PROPERTY IS THE MOST STRESSFUL THING YOU'LL EVER DO. FOR THOSE THAT HAVE DONE IT, I'M SURE YOU'LL ATTEST TO THIS FACT. HOWEVER, IN MY OPINION, YOUR FIRST PROPERTY DOESN'T COMPARE TO THE EVENTUAL UPGRADE IN WHICH YOU NEED TO SELL YOUR CURRENT PROPERTY IN ORDER TO MOVE INTO A NEW ONE.
If you’re currently considering doing this or you’re interested in finding out how it can be done, this post will seek to outline the some of the options available to you to make the process a little easier for you.
First up, why do I say the upgrade is so stressful? For most people who are upgrading, it’s not possible to keep their existing property as usually maintaining loans on both will be too much of a strain on cash flow.
This means that the residual cash from selling your current property will need to be used for the upgrade. However, where are you meant to live if you’ve got to sell your current property first before you purchase the next?
That’s the stress I’m talking about.
When dealing with clients on this matter there are usually three options I provide for them depending on their risk tolerance.
Option 1 – Sell your current property with a delayed settlement
For those that are confident in their ability to buy and sell, the first option is to sell your current property with a delayed settlement and then time your next purchase so that both properties settle simultaneously.
When selling a property, after exchange happens, (which is where you put down your 10% deposit) there is usually a six week period before settlement occurs (which is when you need to hand over the keys and vacate the property).
Another way to do this would be to have a condition on your Contract of Sale to extend the settlement period to twelve weeks. This will essentially give you three months to find your next property.
With this strategy there are two main risks:
- You only have three months to find your next property
- You have to line up a simultaneous settlement on both properties so that you can move out and in on the same day.
Option 2 – Obtain bridging finance
Bridging is when a bank funds the entire purchase of the next property first and then allows you six months to sell your current property.
To give you an example, let’s say that you’re got a two bedroom apartment worth $800,000 with $200,000 owing and are looking to upgrade to a three bedroom house worth $1.2M.
What the bank will do is calculate what they think your end loan will be after you sell your current property. Using the same example, they do this in three steps:
Step 1 – How much money do you need for the initial purchase?
- Purchase price: $1,200,000
- 10% deposit: $120,000
- Stamp duty + other (5%): $60,000
- Total funds required: $1,380,000
Step 2 – How much money will you have from the sale of your current home?
- Sale price: $800,000
- Agent fees + other (2%): $16,000
- Payout of existing loan: $200,000
- Total residual: $584,000
Step 3 – What will the end loan be after you use the residual money to pay down the funds for the new purchase?
- Existing loan: $1,380,000
- Residual money from sale: $584,000
- End loan: $796,000
Of course, what you’ll notice with bridging finance is if you upgrade before you sell your current home, you’re going to end up with two loans, one for $1,380,000 and another for $200,000. For most, the repayments on both are not manageable.
Banks understand this so when you upgrade, what they’ll do is give you two loans:
- Loan 1 (end loan): $796,000
- Loan 2 (bridging loan): $584,000
For the end loan, you’ll need to make repayments just like any other loan. However, for the bridging loan, what they’ll do is allow interest to capitalise until you can pay it out once you’ve sold your current home. As such, whilst there is still a cost involved, the capitalising loan does not place any strain on your cash flow.
With this strategy the two things you need to consider are:
- You must sell your current home within six months or the bank will do it for you…
- The bridging loan tends to be with an interest rate 1% higher than the end loan, which is how the banks make their money on this strategy.
Option 3 – Sell your current home, rent for six months and then upgrade
Finally the least risky is the third option, simply focusing on selling your current home so you know exactly what you will have available for your next purchase, rent for six months and then buy as you would for a normal purchase.
The two major objections with this strategy for families are:
- You will have to do a double move; initially for the place you rent and then again when you upgrade. I know I don’t need to elaborate on this much as to why this would be an objection as we all hate moving!
- The place you rent tends to not resemble in any way the property you are looking to buy so the entire family is pretty grumpy during this rental period.
So there you go, three different strategies starting from most risky and ending up most conservative. I’ve seen all three work completely seamlessly and ultimately I think it comes down to your risk appetite in addition to the type of property you are looking to buy or sell that will dictate which strategy works for you.