Bridging loans: financial helping hand or potential pitfall?
Let’s imagine you’ve found the house of your dreams. The only problem is that your current property is still on the market and you don’t want to rent temporary accommodation while waiting to move into your future home. A bridging loan may be the solution. How does it work? What are the advantages and what should you keep in mind?
Tobias owns his apartment in Luxembourg. He wants a larger home and has found a nice house on the outskirts of the capital. He needs to make up his mind quickly, though, otherwise the house could be snapped up by somebody else. The difficulty is that he’s only recently put his one bedroom apartment up for sale and he hasn’t found a buyer yet. That’s when he hears about bridging loans. But what exactly is a bridging loan?
Bridging loans: buy first, sell second
A bridging loan (also known as a bridge loan) is an advance granted by a bank to enable a homeowner looking to move house to finance the purchase of a new home before selling the previous one. This short-term loan is generally used to bridge the gap between the sale of the borrower’s current home and the purchase of a new property.
The principle is simple: the bank lends part of the sale price of the old home over a short period of time: generally between 12 and 24 months. Until the property is sold, the beneficiary pays only the interest on the loan. In principle, the full amount of the loan is repaid in one lump sum, before the maturity date, as soon as the sale of the old property is complete.
→ Useful info: The bridging loan lending criteria are the same as for a traditional mortgage. The bank will check Tobias’s application, his income, his debt load, his saving capacity, whether his accounts are well managed, etc.
Bridging loans can take various forms. In most cases, the proceeds from the sale of the first property aren’t enough to cover the new purchase. The borrower will therefore take out a traditional long-term mortgage on top of the bridging loan. The two types of loans are part of the financing plan for the new home.
More rarely, the proceeds from the sale of the first property are sufficient to cover the new purchase and there’s no need to take out an additional mortgage.
To determine the amount of the bridging loan, the bank relies on the apartment’s estimated resale value from which it deducts any outstanding amounts.
In Tobias’s case, the sale of his apartment won’t cover the purchase price of his new house. Tobias will therefore pay the interest on his bridging loan and the monthly mortgage payments (interest and capital) until he finds a buyer for his apartment.
→ Useful info: To determine the amount of the bridging loan, the bank relies on the apartment’s estimated resale value from which it deducts any outstanding amounts: balance of the outstanding mortgage on the property for sale, agency fees, government grants, early repayment charges, etc.
Bridging loans: all the benefits of flexibility…
A bridging loan seems like an appealing option for Tobias. With this type of loan, he won’t be forced to sell his apartment in a hurry and he’ll have the best possible chance of securing his house. Plus, he’ll be able to move into his new home straight away, without having to rent another property in the meantime.
And, with a bridging loan, he can choose to only pay the interest on the loan until he sells his apartment. Finally, provided that he takes out a loan with a variable interest rate, he won’t face any penalties if he repays it early (as he would with a traditional loan).
Bridging loans help to expedite property transactions.
Bridging loans help to expedite property transactions. Tobias must be cautious, though, since this type of loan also involves risks that have to be taken into consideration.
… but not without risk
Before opting for a bridging loan, Tobias must also understand the limitations of this type of product.
An accumulation of several loans
A bridging loan is very often linked to a traditional mortgage. Tobias must be able to cover the financial cost of two loans, or even three if the loan on the apartment that he’s put up for sale hasn’t been repaid yet.
→ Tobias needs to run simulations with his relationship manager to work out his debt load and his ability to service several loans.
The longer the property is up for sale, the more the bridging loan will cost.
Often higher variable rates
Bridging loans usually come with a variable interest rate. As the loan is, in principle, repaid as soon as the property is sold, this avoids early repayment charges. On the other hand, variable rates are often higher than fixed rates. Everything depends on the borrower’s specific circumstances.
The cost increases with time
The longer Tobias’s apartment is up for sale, the more his bridging loan will cost. It’s in his interests to repay his bridging loan quickly so he can stop making monthly interest payments.
Consequences of not meeting deadlines
A bridging loan is a temporary solution over a short period of time. If Tobias realises that he can’t find a buyer, he needs to tell his relationship manager as soon as possible in order to find a solution tailored to his situation. In most cases, the bridging loan will be extended or a new loan will be proposed.
→ To avoid this, Tobias needs to sell his apartment quickly. The estimated sale price must be realistic and take account of factors such as the condition of the property, its location and the wider economic context. In that respect, it would be a good idea to call on one or more real estate experts.
Tobias now has a clearer idea of how a bridging loan works. He can make an appointment with his relationship manager, who will produce numerical simulations for him and help him choose the most appropriate option.
If, in the end, Tobias decides that the risk is too great and a bridging loan isn’t the right solution for him, he can start by selling his apartment, then rent a property while waiting to find his dream house. The sale will provide him with a lump sum to put towards his new home.