Bridging loans are an increasingly popular form of finance, especially in the property development industry. This is for good reason: bridging loans offer a series of advantages that make them an ideal choice for fast-paced, competitive markets such as the property market. When properly utilised, bridging loans can afford a discerning property developer greater flexibility and improve the profitability of your next investment. However, bridging loans are not a one-size-fits-all solution. As with any form of finance, bridging loans have their pros and cons, making them best suited in some applications, while lacklustre in others. This raises the question – should you apply for a bridging loan?
In this article, we will break down how bridging loans work, discuss their advantages and disadvantages, and conclude whether bridging loans are right for you. Let’s get started.
What is a bridging loan?
Bridging loans are a form of secured finance that specialises in offering borrowers a short-term solution to their financial needs. Typically, bridging loan terms last mere months, and often do not exceed a year in total. Borrowers are expected to either make a full repayment within this term, often through the sale of an asset, or refinance the bridging loan using an alternative form of finance.
As a secured loan, bridging finance requires the borrower to put forward assets as collateral. In practice, assets are generally of the same type as the asset being purchased. For example, borrowers looking to purchase a new property will put forward an owned property for use as collateral. The bridging loan lender will then place a lien against the property, accepting it as collateral and entitling them to seize the property if the borrower defaults. While this does constitute a higher level of risk for borrowers than with unsecured loans, this collateral requirement is where bridging loans derive their key advantages, which we will discuss later.
How do bridging loans work?
Bridging loans work by “bridging the gap” between a purchase, and the raising of funds. In other words, this form of finance aims to quickly and briefly cover the shortfall, allowing borrowers to act at a moment’s notice as opportunities arise, without having to rush through the sale of an asset or the application process for other loan types.
Prospective borrowers can obtain a bridging loan through one of several lenders. If you are in the market for a bridging loan, you may be able to find one on offer at your bank. Banks don’t often advertise bridging loan products, so you might consider asking your bank whether they offer the service, even if it isn’t advertised. Alternatively, you may find bridging loan lenders at bridging loan hubs. These private hubs aim to introduce borrowers and lenders based on each others’ needs, such as required loan amount, time frame, and so on. If both parties approve, a loan agreement can be signed and funds released in short order, typically within a few days.
Once you receive the money stipulated in your loan agreement, you may purchase your next property, or another asset if appropriate. This purchase can be made in the form of a cash offer, something that is quite appealing to any seller. If the deal goes through, your next step will be loan repayment. Bridging loan repayments are typically made through one of two ways. Firstly, the borrower can raise funds for repayment through the sale of an asset, often the same asset the loan is secured against. Secondly, the borrower can refinance their bridging loan using a more traditional form of finance. Mortgages are the most common form of refinancing for bridging loans.
Advantages of bridging loans
Bridging loans have a range of advantages, with most making them an ideal solution for property developers. The most impactful advantages are as follows:
- Fast access to finance – The primary advantage of bridging loans is speed. While there is some variation depending on the lender, borrowers can expect to receive their loan amount within as little as a couple of days.
- Streamlined application process – Application processes are often a bottleneck when obtaining a loan. Even if you meet the requirements, traditional loans require you to complete stringent checks to make certain your eligibility. Bridging loans, however, are much quicker, thanks to the requirement of collateral. If you have an asset of sufficient value, and a professional valuation certificate, your application can be processed remarkably fast.
- Flexibility – Bridging loans are defined by flexibility. They have a wide range of applications, accept a variety of assets as collateral, and even have some flexibility when it comes to repayments. How you pay your interest, for example, can be negotiated to fit your needs.
Disadvantages of bridging loans
Although bridging loans have several key advantages, they have certain disadvantages that could be deal breakers for some borrowers. These disadvantages include the following:
- Higher risk – Bridging loans generally pose a higher risk to borrowers than unsecured loans. They require collateral, which can be seized by lenders if borrowers cannot make repayments. While such a risk can be sustained by some, borrowers in a precarious financial position might find it intolerable.
- Expensive – Bridging loans are typically more expensive compared to other loans. Although the specifics vary between lenders, most bridging loans come with fairly high interest rates that can make the loan costly. In some cases, borrowers must make interest payments on their bridging loans while also covering an existing mortgage, putting even more pressure on a borrower’s finances.
- Requires collateral – Bridging loans derive many of their benefits from the requirement of collateral. However, if a prospective borrower lacks assets of sufficient value, bridging loans are simply not an option.
Should you apply for bridging loans?
Bridging loans are an exceptionally useful tool in certain industries, with property development firmly at the top. These loans boast a set of advantages that make them a competitive choice, and can mean the difference between seizing a lucrative development opportunity and watching competitors beat you to the punch. For property buyers and developers in a comfortable financial position, bridging loans may offer opportunities that are difficult to find elsewhere.
However, bridging loans are a comparatively costly and risky option. Without a firm financial position to rely on, bridging loans can make your finances much worse, especially if important assets are seized due to default. As such, it is important to obtain professional financial advice before taking on a bridging loan to make sure it’s the right choice for you.