Moving from one home to the next: Complex transitional financing
Our housing needs change as we get older, and a smaller apartment could be a better option than staying in the current family home. In most cases, though, people need the capital raised from selling their current home in order to purchase a new property. Transitional financing can be used to bridge the period between purchasing a new property and selling your current home, ensuring that everything runs smoothly.
What is interim financing?
Interim financing, also known as transitional financing, is provided by banks to help people purchase a new property – by granting them a temporary loan until the old property is sold, for example. Assuming that affordability has been verified, a bank may agree to finance 80% of the purchase price of the new home, for instance. The bank might also impose a requirement that the current property be rented out for a certain amount of money in the meantime, ensuring that the property is self-supporting.
How does interim financing work?
With interim financing, the bank establishes the borrower's financial situation and reduces the credit risk to the extent possible. In other words, the purchase of the new property must be affordable. With this in mind, the bank usually applies imputed interest of 5% when calculating affordability. In addition to the repayment costs for the second mortgage, 1% of the property value is also included to reflect ongoing maintenance and ancillary costs. Lastly, the sum of all the costs must not exceed one-third of the borrower's gross income.
Avoiding financial risks from interim financing
Even if the rental of your current home is factored in, there are still risks involved in owning two properties at once – such as the home not being rented out or a loss of income. It is therefore advisable to have the existing property valued and to sell it in the medium term. If the market value of the property has increased due to its attractive location, for instance, you may be able to free up additional funds once the existing mortgage and the real estate gains tax have been factored in.
New home as a replacement purchase
Selling a property involves real estate gains tax, as financial resources are no longer tied up in the home and hidden reserves are dissolved. However, the tax may be deferred if a new home is purchased with the proceeds of the sale, i.e. if the property is a replacement.
Avoiding real estate gains tax through a replacement purchase
Before purchasing a new home, you should check if you are eligible for a tax deferral due to the home being a replacement purchase. If the investment costs for the existing house are higher than the price of the new property, you cannot assert that the purchase is a replacement. In some cases, such as when the new property is being purchased by just one half of a couple, it may be possible to make a partial claim under the replacement purchase rules.
Tips for interim financing
It is important to weigh up everything carefully when considering interim financing. We have summarized the most important tips in a brief overview:
- Apply to the bank for a loan or mortgage for the new property as soon as possible, and consider different solutions.
- Interim financing can entail unforeseen costs. Find out about the repayment options offered by your lender.
- A property valuation will allow you to find out whether your home has increased in value. Have the market value assessed by an expert.
- Real estate gains tax when selling an existing property can be deferred under certain conditions.