What Is Loan Capitalisation and What Does It Mean for Bridging Loans in Armadale, Fremantle or South Perth?

Are you thinking about pursuing bridging loans in the Perth area? If you are ready to make an offer on a new house but haven’t sold your old one yet, then this form of home to home financing will likely present itself as an attractive option. However, if you are thinking about applying for a bridging loan, it is important to recognise some of the risks that come with it. One of the biggest of those risks is known as loan capitalisation.

Understanding the Basics of Capitalisation

To understand how capitalisation works in relation to bridging loans, you need to be aware of another risk behind bridge financing: high-interest rates. Bridge loans will vary a bit from one situation to the next but generally come with high-interest rates. Buyers are willing to take on this higher interest rate because they hope it will only be temporary. The bridge loan gives you the capital you need to make the down payment on a new house. Then, when your first house sells, you can use that money to pay off the bridge loan, plus interest.

Said another way, you are essentially using equity from your first house to buy your second house. Say you are looking for a bridging loan in Fremantle or Armadale to make a down payment of $30,000 on a new house. Under a bridging loan, a lender will give you that money under the condition that you pay them back when your current house sells. Now, say your current house has an expected sale price of $140,000, and your equity is 40%. If your house sells, you should get about $56,000 (with the rest of the money paying off your remaining mortgage). That money is more than enough to cover your new down payment, which is why many homeowners prefer to sell their first house before they buy a new one.

When you seek bridging loans in Armadale or South Perth, you end up with more of a month-to-month burden than a regular mortgage. You essentially end up with two mortgage payments, plus the high interest rate of the bridging loan. If you have a reasonable amount of cash on hand and have a few potential buyers already lined up for your house, this kind of situation might be tenable for you. If the extra expense is going to stretch you beyond your financial means, or if you think your first house could take another six months to sell, then a bridging loan might be a bigger risk than you can take.

That brings us back to capitalisation. So long as you are making interest payments on time, you shouldn’t have to worry about capitalisation. However, if you get to the point where you can only cover your mortgage payments and can’t pay the interest on the bridging loan, your lender will ‘capitalise’ the interest. When that happens, they add your unpaid interest to the principal balance of your loan, which means you will owe your lender more when you eventually sell your home and clear the bridging loan. Because of the way bridging loans work, those repayments essentially reduce the amount of equity you have in your first house.

Talk to a Professional about Bridging Loans in Fremantle, Armadale or Perth

If you are thinking about bridging loans in Armadale, South Perth or Fremantle, it’s a good idea to speak with a professional to weigh the potential risks and benefits. At Peter Dunn Finance, we are happy to answer any questions you might have about bridge financing, loan capitalisation, equity or any other matters of real estate buying and selling. Call us on 0427 947 480 to schedule an appointment.