Top 5 Risks of Bridging Loans (And How to Avoid Them)

What Is a Bridging Loan?

A bridging loan is a short-term loan designed to cover the gap between the sale of your current property and the purchase of a new one. It allows you to buy your new home before your existing home sells, which is especially helpful if you find your dream home and don't want to risk losing it while waiting for your current property to sell.

Bridging loans are typically secured loans, meaning they are backed by your current property (which is being sold) and the new property (which you are purchasing). These loans usually have short terms, ranging from 6 to 12 months, and must be repaid quickly.

There are two main types of bridging loans:

• Open Bridging Loans: These loans do not have a fixed sale date for your current home. They are more flexible but also riskier, as there is no defined repayment timeline.
• Closed Bridging Loans: These loans are secured against the sale of your existing property, with a set settlement date for the sale of your current home. They offer greater certainty, as there's a clear repayment timeline.

While these loans can be beneficial in a fast-moving market or when you don't want to rush your sale, it's crucial to understand the risks involved before choosing this financing option.

Top 5 Risks of Bridging Loans

While bridging loans offer a convenient solution for purchasing a new home before selling your current one, they carry risks that can lead to financial strain if not properly managed. In this section, we'll discuss the top 5 risks associated with bridging loans and how to avoid them.

Risk #1: Property Sale Delays

One of the primary risks of a bridging loan is the delay in selling your property. If your home doesn't sell as quickly as expected, you could be left with both a new and an old mortgage, which can be financially overwhelming.

In the current property market, sales can sometimes take longer than anticipated, especially if you're in an area where homes aren't selling as quickly as they once did. If you find yourself stuck with an unsold property at the end of the bridging loan term, you'll be under pressure to either extend the loan or make higher repayments, both of which can strain your finances.

How to avoid it:

The best way to mitigate this risk is to sell your current property before taking out a bridging loan. If this isn't feasible, it's important to secure a buyer early on in the process, or at least have a solid pre-listing commitment. Additionally, make sure your home is priced competitively to attract potential buyers quickly.

Another approach is to have a contingency plan in place. Consider saving extra funds or securing temporary financing options to cover any unexpected delays in the sale.

Risk #2: High Interest and Ongoing Costs

One of the most significant drawbacks of a bridging loan is the higher interest rates compared to standard home loans. Because bridging loans are short-term and considered higher risk for lenders, they often carry interest rates of 5-8% annually, which are considerably higher than typical mortgage rates.

Additionally, since interest may be calculated daily and charged monthly, the longer you hold the loan, the more it can accumulate. Over time, this can add significantly to your overall debt, especially if the sale of your property is delayed.

Beyond interest rates, there are other associated costs, such as valuation, legal, and discharge fees, that can quickly add up and increase the total cost of the loan. These fees may be upfront or added to the loan balance, further increasing your debt burden.

How to avoid it:

To mitigate this risk, shop around for the best interest rates and loan terms. Don't settle for the first offer you receive, comparison is key. Some lenders may offer lower rates or more favourable conditions, so it's important to understand the total cost of the loan, including all fees, before making a decision.

If possible, consider paying interest-only during the bridging period, as this will help to ease your cash flow. Just be aware that some bridging loans may capitalise interest (i.e., add it to the loan balance), which can increase your overall debt.

Lastly, make sure to factor in all potential hidden fees and be prepared for the total cost over the loan's duration.

Risk #3: Peak Debt Pressure (Double Mortgage Stress)

When you take out a bridging loan, you are essentially managing two mortgages simultaneously: your existing home loan and the loan for your new property. This can place significant financial strain on your budget, especially if your old property doesn't sell as quickly as expected.

During the bridging period, you may find yourself with an elevated “peak debt“, the total amount owed on both properties, which can lead to substantial monthly repayments. If your current home sells for less than anticipated or the sale is delayed, you could end up with negative equity (owing more than the property is worth), adding even more stress to your financial situation.

How to avoid it:

To manage this risk, ensure you understand your Loan-to-Value Ratio (LVR) and have sufficient equity in your current property to cover both mortgages, if needed.

Be conservative in your property valuation, don't overestimate what you expect to sell your home for. It's also crucial to budget carefully and maintain a financial buffer to help manage the peak debt.

If possible, work with a trusted mortgage broker to assess your financial capacity and ensure you won't over-leverage yourself.

Risk #4: Repossession or Forced Sale Risk

Since a bridging loan is secured against both your current property and the new property, one of the most serious risks is repossession or a forced sale. If you're unable to repay the loan within the agreed time frame, whether due to delays in selling your current property, market downturns, or other financial issues. The lender may take action to recover the debt, including repossession of one or both properties.

This could lead to selling your properties in a forced sale, which often results in lower sale prices and potentially leaves you with a large outstanding debt.

Additionally, if the market is slow or if you need more time to sell, you could find yourself in a financial situation where the loan becomes unmanageable, leading to additional costs and severe long-term economic consequences.

How to avoid it:

To reduce the risk of repossession or forced sale, it's important to have a contingency plan in place. Consider securing additional backup financing or building up extra savings to cover any unexpected delays.

Also, be transparent with your lender early on if you anticipate problems, as they may be able to offer extensions or alternative solutions if your sale is delayed.

Lastly, avoid over-leveraging your financial situation. Take a cautious approach, ensuring that your debt levels remain manageable and that you have a solid exit strategy.

Risk #5: Unsuitable for Low Equity Borrowers

Bridging loans are not ideal for low equity borrowers. To qualify for a bridging loan, lenders typically require you to have a significant amount of equity in your current property. If you don't have enough equity, the lender may either reject your application or offer you less favourable terms, making it harder to manage the loan.

Since bridging loans involve the risk of negative equity in both your old and new properties, lenders are cautious about the potential for negative equity, especially if property values drop or your current home takes longer to sell. Without sufficient equity, you may find it difficult to cover both loans, which can lead to additional stress or financial hardship.

How to avoid it:

Before applying for a bridging loan, make sure you have at least 50% equity in your existing property. This gives you a better chance of securing a loan with favourable terms. If you have limited equity, you may want to explore alternatives such as deposit bonds or other short-term financing to help you make the transition without taking on too much risk.

Working with an experienced mortgage broker can also be crucial here. They can help assess your equity position and guide you toward the best options based on your financial situation.

How Stryve Finance Helps You Minimise Risk

At Stryve Finance, we understand that navigating property financing can be overwhelming, especially when it comes to bridging loans. Our team of experienced mortgage brokers is here to help you minimise the risks and make sure you're making the right financial decisions every step of the way.

Here's how we can assist you:

By working with Stryve Finance, you'll have an experienced partner on your side, guiding you through the complexities of bridging finance and helping you navigate potential pitfalls. Our goal is to ensure that your property goals are achieved with minimal risk and maximum financial security.

Conclusion

While bridging loans can be a handy tool for purchasing a new home before selling your current one, they come with significant risks that need to be carefully managed. From property sale delays and high interest rates to the stress of working two mortgages simultaneously, it's essential to fully understand the potential downsides before proceeding.

At Stryve Finance, we specialise in helping our clients navigate these risks, ensuring that you make informed decisions every step of the way. By working with us, you can take advantage of personalised strategies, expert advice, and access to a wide range of lenders who offer tailored bridging loan solutions that best fit your needs.

If you're considering a bridging loan but are concerned about the risks involved, book a free 15-minute Bridging Loan Risk Review with one of our experienced mortgage brokers today. Let us help you make your property transition as smooth and financially secure as possible.