Caveat Financing: What Is It?
Caveat financing refers to short-term loans that can last anywhere from two weeks to two years or more. Also known as bridging loans, this type of financing is typically used by home buyers to cover the period between the sale of an existing home and the purchase of a new home.
How caveat loans work
Caveat loans can be understood as a short-term second mortgage over the borrower’s existing property. Once the existing house is sold, the buyer or homeowner pays off the caveat loan using the proceeds from the property sale. Caveat financing can therefore be useful for homebuyers who are unable to sell their existing home before purchasing a new house.
As these loans are quickly approved and are designed to fill a short-term need, caveat loans can be more expensive than traditional home loans. Some caveat loans are closed loans, which means they are for a predetermined period of time. In rare cases caveat loans are open loans, which means they have no specified end date, though repayments may need to begin by a specified date.
Purpose and advantages
Caveat financing is usually used by homebuyers who want to buy a property quickly, before they are able to sell their existing home. There is less pressure for homeowners to sell their property fast and the loan gives homeowners more time to find the right buyer at the right price. However, caveat loans can be also used by businesses seeking a cash-flow injection and other users who need short-term financing.
Terms and conditions
The terms and conditions that apply to caveat loans will vary depending on the lender. Common terms and conditions include the following.
- Interest only or capitalised:A caveat loan might offer interest-only repayments before the end date, or it might be completely capitalised. In this case, repayments would be deferred until the end date of the loan.
- Duration: Caveat loans are short-term loans. Caveat loans can be for any period ranging from two weeks to two years or more, but they usually last for 3-12 months.
- Security: The caveat loan is usually secured over the buyer’s existing property, so it operates likes a second mortgage over the property.
- Loan-to-valuation ratio (‘LVR’): The loan-to-valuation ratio will vary depending on the lender, but the borrower might be able to find a loan with as much as 80% or 95% LVR. Some lenders might offer only 65% or 75% LVR.
- Set-up costs: As with any type of loan, set-up costs and servicing fees will apply. These may vary from lender to lender and the other terms and conditions of the loan.
- Repayments: The borrower might be able to defer payments until he or she sells an existing home, or the loan might come with an interest-only condition. The agreement might require the borrower to repay the entire loan once the former home is sold.