The Costs of Bridging Loans: What to Expect and How to Budget
Bridging loans can provide a valuable financial solution for homeowners transitioning between properties, but they come with a distinct set of costs. Understanding these expenses—from interest rates to additional fees—can help you make an informed decision and budget effectively. In this guide, we’ll explore the various costs associated with bridging loans in Australia, explain how to estimate these expenses, and offer tips on how to manage them.
What is a Bridging Loan?
Bridging loans are short-term loans designed to cover the financial gap between purchasing a new property and selling an existing one. These loans allow you to secure a new home without waiting to sell your current property, providing flexibility in competitive markets. Bridging loans typically last between 6 and 12 months, though they can sometimes extend longer. However, because of their short-term nature, bridging loans generally have higher costs than standard home loans.
Overview of Bridging Loan Costs
The costs of bridging loans can be grouped into several main categories:
Interest Rates
Loan Fees
Holding and Property Costs
Exit Fees and Other Charges
Understanding each category is crucial to accurately budgeting for a bridging loan and ensuring that it aligns with your financial goals.
1. Bridging Loan Interest Rates
One of the primary expenses of a bridging loan is the interest rate, which tends to be higher than a standard mortgage due to the increased risk for lenders. Bridging loan interest rates in Australia typically range between 6-12%, though rates vary based on factors like the loan structure, lender, borrower’s credit profile, and the type of bridging loan (open or closed).
Key Factors That Influence Bridging Loan Interest Rates
Loan Type
Open Bridging Loans (for buyers who have not yet sold their existing property) often come with slightly higher interest rates due to the uncertainty around when the current property will sell.
Closed Bridging Loans (for buyers with a confirmed settlement date for the existing property) usually offer more favorable rates because lenders perceive them as lower risk.
Loan Term
Since bridging loans are short-term, lenders charge higher interest to mitigate risk, especially if the term exceeds 12 months.
Creditworthiness of the Borrower
Lenders may adjust rates based on the borrower’s credit score, income stability, and debt-to-income ratio.
Types of Interest Payments
Interest-Only Payments: Most bridging loans are structured with interest-only payments during the bridging period, allowing borrowers to avoid paying down the principal until the existing property is sold.
Capitalised Interest: Some lenders offer capitalised interest, where the accrued interest is added to the loan balance, reducing the need for monthly payments during the bridging term.
Example: Calculating Bridging Loan Interest
Consider the following scenario:
New property purchase price: $800,000
Remaining mortgage on existing property: $200,000
Estimated sale price of existing property: $600,000
Bridging period: 6 months
Interest rate: 6%
Step-by-Step Calculation
Determine Peak Debt
Peak debt is the total loan amount needed to cover both properties. In this example, it’s $1 million ($800,000 for the new property + $200,000 remaining mortgage).
Calculate Monthly Interest
Monthly interest on peak debt = (Peak Debt x Interest Rate) / 12 months
For $1 million at 6% interest, monthly interest = $5,000
Total Interest for Bridging Period
Total interest over 6 months = $5,000 x 6 = $30,000
Interest costs vary depending on the loan term, so it’s essential to consider how quickly your current property is likely to sell.
2. Bridging Loan Fees
In addition to interest rates, bridging loans come with a variety of fees. While these fees differ among lenders, it’s common to encounter several charges in the application and loan management process.
Common Bridging Loan Fees
Application or Establishment Fee
The application or establishment fee is a one-time charge that covers the cost of processing the loan. This fee can range from $500 to $1,500 or a percentage of the loan amount.
Valuation Fees
Bridging loans typically require valuations of both the existing and new properties to determine the peak debt accurately. Valuation fees vary but are usually $300 to $600 per property.
Legal Fees
Some lenders charge legal fees to cover the cost of documentation and legal procedures. Legal fees are generally between $200 and $500 but can be higher for complex applications.
Administration or Handling Fees
Some lenders apply administration or handling fees for managing the loan throughout the bridging period. These fees vary widely but may cost $10 to $50 per month.
Exit or Early Repayment Fees
Some lenders impose exit fees if the loan is repaid before the agreed term ends. Early repayment fees are often 1-2% of the loan balance and should be clarified during the application process.
Example: Total Bridging Loan Fees
Let’s estimate total fees for a bridging loan:
Application Fee: $1,000
Valuation Fees: $500 for each property = $1,000
Legal Fees: $300
Administration Fees: $20 per month for six months = $120
Exit Fee: $1,500
Total Estimated Fees: $3,920
These fees add up quickly, so it’s essential to account for them in your overall budget.
3. Holding and Property Costs During the Bridging Period
Apart from the loan-specific costs, borrowers need to budget for holding and property costs. Since you’ll own two properties during the bridging period, additional expenses arise:
Mortgage Payments on Existing Loan
If your current mortgage doesn’t switch to interest-only, you may have to make principal and interest payments on this loan in addition to interest on the bridging loan.
Property Taxes
You’ll be responsible for council rates and property taxes on both properties during the bridging period.
Insurance
Comprehensive insurance is usually required on both properties by the lender. Home and contents insurance on both properties can add up, especially if one is a larger, newly purchased home.
Maintenance and Utility Costs
Owning two properties means handling maintenance and utility expenses for both, even if the existing property is unoccupied.
4. Exit Fees and Other Charges
Exit fees and other charges are important to consider for bridging loans. These may include:
Early Repayment Charges: Charged if the loan is repaid ahead of the scheduled end date.
Break Fees: If you break a fixed-rate loan term, the lender may impose a break fee.
Extension Fees: If the sale of your current property is delayed, some lenders offer extensions for an additional fee, generally $1,000 to $2,000.
These charges vary significantly by lender, so reading the loan terms carefully is crucial.
Budgeting Tips for Bridging Loans
Planning and budgeting are critical when considering a bridging loan. Here are some practical tips to help you stay financially prepared:
Calculate Peak Debt and Monthly Interest
Understanding your peak debt and estimated monthly interest can help you gauge whether bridging finance is affordable for your circumstances.
Plan for Holding Costs
Factoring in the holding costs for two properties, including maintenance, insurance, and property taxes, will help prevent unexpected expenses.
Set Aside Funds for Fees and Charges
Include application fees, valuation costs, and potential exit fees in your budget. Consulting with your lender or broker for a detailed list of fees can provide a clearer picture.
Consider Potential Delays in Selling Your Existing Property
Property market fluctuations can affect the time it takes to sell your current property. A conservative approach to budgeting will help if your property sale takes longer than anticipated.
Evaluate Your Exit Strategy
Work with your mortgage broker to plan a feasible exit strategy. Be sure you understand the loan’s repayment schedule and conditions for refinancing or transitioning to a standard mortgage.
Conclusion: Managing the Costs of a Bridging Loan
Bridging loans can ease the transition between properties, but they come with various costs that add to the financial commitment. By understanding the interest rates, fees, and other expenses involved, you can budget more effectively and decide if bridging finance is the right choice for you.
When planning your property transition, it’s essential to weigh the costs against the benefits. Consulting a mortgage broker can help clarify the loan’s structure, provide accurate cost estimates, and offer guidance on managing the financial commitment.
At Mountain Mortgages, we’re committed to helping our clients navigate complex financing solutions like bridging loans. Reach out to us today to discuss your specific needs, understand the costs involved, and receive expert support in planning your next property move. With the right planning, bridging finance can help you achieve a smooth transition without the financial stress.
