How bridging loans can catch out home buyers
Upgrading to a new house before you sell the old one requires some careful planning with your lenders. Photo / Fiona Goodall COMMENT: With the new 60% Loan to Value Ratio (LVR) limits and tax changes practically in place for investment properties, homeowners are investigating upgrading their homes instead of buying investment properties. Due to the lack of stock, some buyers are wanting to make sure they lock in a new home prior to selling their previous home, financed using a product called a Bridging Loan.
The most common scenario for a bridging loan is for someone who is looking to upgrade to a new home but won’t have sold their current home before settling on the new property. Prior to the LVR restrictions, a bank could lend 80% against the current home and 80% against the new home. If the borrower couldn’t sell their old home, the worst outcome would be having to rent out one of the homes (making it an investment property). But now that the maximum someone can borrow against an existing investment property is 60%, this type of deal is more likely to be done as a bridging loan. There are two types of bridging loans and it all comes down to if you know the settlement date of your existing home - the one you are selling. Let’s say you know your current home is settling on August 1 but your new home is going to be settled a month prior, on July 1. This is a closed-bridge deal because both dates are set in place. Closed bridges are reasonably easy to finance if you have enough equity.
It’s low risk to the bank, even if your income isn’t quite enough to pay the entire mortgage for that crossover period, because the bank knows exactly when this short-term loan is going to end. The second type, an openbridge, is when you know the settlement date of your new home and have the intent to sell, but not the finalised settlement date of your current home’s sale. For obvious reasons, this is a much higher risk to the bank because if the market slows down over the next few months, it may be difficult or impossible to sell your existing home.
As I mentioned earlier, it would have been possible in the past to rent out your previous home as an investment property. However these days this could mean the bank has breached the LVR restrictions which comes with heavy penalties. Open bridging loans are therefore a little trickier to finance particularly around the 70%-80% LVR level.
A word of caution here. Telling the bank you have the intent to sell when you don’t is likely to land you in a whole heap of inescapable legal issues. Don’t be tempted to use an open bridging loan as a way to get around the investment property LVR rules.
If you plan to make use of a bridging loan (ie; buy a new home before you sell your existing home) there are a number of things to decide. Firstly, what is the lowest price you will sell your current home for? Is that realistic? Can you buy your next home with the proceeds from that sale (ie; are the houses you’re looking at buying in your price range)? Can you list your property and ask for an extended settlement date, thereby taking the pressure off you finding a home and “shortening your bridge”.
Next, with numbers in hand, start looking for finance pre-approval. It is best to start with the easiest finance option and work your way down the list to the more expensive options.
The easiest option is if you have enough equity that you could purchase the new home and, in the worst case scenario of not being able to sell the previous home, rent it out as an investment property. In this instance, you aren’t using a bridging loan but presenting the bank with an acceptable worst case scenario.
If that scenario doesn’t work, begin investigating a bridging option with a main bank. If that doesn’t work, there are a number of options with non-bank lenders. Non-bank lenders are more expensive than main bank lenders but most people who use them view the expense as a cost of getting their dream home. In other words, if you could buy your dream house for $1.5m, would you walk away at $1.52m? If not, then the additional $20k of bridging expenses is just the price of your upgrade. Equity plays a big part in most bridging finance deals as lenders don’t like to go much above 80% on your properties. Most people need 100% of the purchase price of the new home so, if you’re upgrading, you’ll likely need to be at less than 60% LVR on your existing home before you start (that is, have more than 40% equity in your home). Fortunately, anyone who has owned a property for more than a month has probably seen some capital growth. Now is the time to make use of it.
Using a bridging loan can come with additional costs and can sometimes involve working with a couple of lenders. But it also allows you to purchase before you’ve sold your home, which opens up your options. Don’t dismiss it as an option if you’re looking to upgrade in this market. - Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.