Bridging Finance vs. Traditional Mortgages: What’s the Difference?
In the dynamic New Zealand property market, homeowners often find themselves in situations where they need to buy a new property before selling their existing one. This is where bridging finance comes into play, offering a short-term solution to bridge the gap between property transactions. However, it’s crucial to understand how bridging finance differs from traditional mortgages to make an informed decision. This article will explore the key differences between bridging finance and traditional mortgages in the New Zealand context.
Understanding Bridging Finance
Bridging finance, as the name suggests, is a short-term loan designed to ‘bridge the gap’ between two property transactions. According to iLender, a leading New Zealand mortgage expert, bridging finance provides a financial solution that offers fast access to funds for property purchase and can be used in various circumstances.
Key Features of Bridging Finance:
- Short-term nature: Typically lasting up to 12 months
- Higher interest rates: Usually set at the lender’s floating rate plus a premium
- Flexible repayment options: Often interest-only payments during the bridging period
- Quick approval process: Can be arranged faster than traditional mortgages
- Two types: Closed bridging finance (when sale dates are known) and open bridging finance (when the sale date of the existing property is uncertain)
Traditional Mortgages Explained
Traditional mortgages, on the other hand, are long-term loans used to finance the purchase of a property. These are the most common type of home loans in New Zealand and come with their own set of characteristics.
Key Features of Traditional Mortgages:
- Long-term nature: Usually 15 to 30 years
- Lower interest rates: Competitive rates, often with fixed and floating options
- Regular repayments: Typically include both principal and interest
- Longer approval process: Requires more extensive documentation and assessment
- Various types: Including fixed-rate, floating-rate, and split mortgages
Key Differences
1. Purpose and Duration
The primary difference between bridging finance and traditional mortgages lies in their purpose and duration. Bridging finance is designed for short-term use, typically when a homeowner needs to purchase a new property before selling their existing one. As MoneyHub points out, bridging loans are not designed to be a long-term situation, and the costs incurred can have long-term effects.
Traditional mortgages, conversely, are long-term financial commitments designed to fund the purchase of a property over many years.
2. Interest Rates and Costs
Bridging finance generally comes with higher interest rates compared to traditional mortgages. According to Mortgages.co.nz, bridging loans often come with the lender’s floating rate plus a premium (such as 1% or 2% p.a. above the floating rate). This higher cost reflects the increased risk and short-term nature of the loan.
Traditional mortgages, being longer-term and lower-risk, typically offer more competitive interest rates. New Zealand banks often provide a range of fixed and floating rate options for traditional mortgages, allowing borrowers to choose the most suitable option for their circumstances.
3. Repayment Structure
Bridging loans often allow for interest-only payments during the bridging period, with the full loan amount due when the existing property is sold. This can provide short-term cash flow relief but requires careful planning to ensure the loan can be repaid when due.
Traditional mortgages usually require regular repayments of both principal and interest from the outset, spreading the cost of the loan over many years.
4. Approval Process and Criteria
The approval process for bridging finance can often be quicker than for traditional mortgages. However, as Squirrel notes, lenders will look closely at affordability, given that bridging finance is an added cost on top of an existing mortgage.
Traditional mortgages typically involve a more thorough approval process, with lenders assessing factors such as income, credit history, and the value of the property being purchased.
5. Flexibility and Risk
Bridging finance offers more flexibility in terms of property transactions, allowing homeowners to secure a new property before selling their existing one. However, this flexibility comes with increased risk. If the existing property doesn’t sell as quickly as anticipated, the borrower may face financial stress managing two loans.
Traditional mortgages, while less flexible in terms of property transactions, offer more stability and predictability in repayments and overall costs.
Pros and Cons
Bridging Finance
Pros:
- Allows purchase of a new property before selling the existing one
- Can reduce stress during the moving process
- Provides flexibility in property transactions
- Quicker approval process
Cons:
- Higher interest rates
- Increased financial pressure of managing two loans
- Risk if the existing property doesn’t sell quickly
- Potential for long-term financial impact if not managed carefully
Traditional Mortgages
Pros:
- Lower interest rates
- Stable, long-term repayment structure
- More predictable costs over time
- Various options (fixed, floating, split) to suit different needs
Cons:
- Less flexibility for property transactions
- Longer approval process
- May require larger deposits
- Long-term financial commitment
Choosing between bridging finance and a traditional mortgage depends on your specific circumstances, financial situation, and property goals. Bridging finance can be an excellent solution for those needing to buy before selling, offering flexibility and reducing the stress of aligning settlement dates. However, it comes with higher costs and increased financial risk.
Traditional mortgages, while less flexible for complex property transactions, offer stability, lower costs, and a range of options to suit different financial situations.
Before making a decision, it’s crucial to carefully consider your options and seek professional advice. As Christopher Walsh, founder of MoneyHub, emphasises, “Working with the right people and lender is essential; if you don’t, the costs can become eye-watering.”
Whether you opt for bridging finance or a traditional mortgage, understanding the differences and implications of each option will help you make an informed decision that aligns with your property goals and financial circumstances in the New Zealand market.