The term bridging loan is used quite commonly in finance, especially property purchasing and development. Yet, for how commonly it appears, it can be difficult to find a clear explanation on exactly what they are and how they could impact you. For a simple breakdown on bridging loans, read on.
What is bridging finance?
Simply put, bridging loans exist to provide people with the means of financing a purchase while they wait for the sale of something. One of the most common examples is when people want to buy a property, but have to wait for their own property to sell before they have the funds to do so. In this example, a bridging loan would allow the purchase of a property, with the loan being repaid after their property is successfully sold.
When considering taking a bridging loan, you should note that they are secured loans. A secured loan is a loan taken against high-value assets. This commonly takes the form of property or plots of land, but can include other assets like yachts or cars.
How do bridging loans work?
Let’s say you are looking to buy a house for £350,000. You would like to put £100,000 down as a deposit and take out the remaining value in a mortgage, but you do not have the money to cover the cost. Say you have £25,000 saved that you could put toward the deposit, with a house valued at £200,000 waiting to be sold. In this case, you could take out a bridging loan for the remaining £75,000 to, as the name suggests, bridge the gap. Once your current house sells, you will repay the loan out of the funds of the sale.
Why take out a bridging loan?
There is a range of reasons to take out a bridging loan. As in the above example, you might need a quick cash injection at short notice to purchase a property while you wait for an old one to sell, but there are many other circumstances where bridging loans could be useful. You could consider taking out a bridging loan to cover the cost of investments or business ventures, paying urgent bills, or covering legal settlements, such as with divorces. Another area where bridging loans are commonly used is property development. This is because they can offer a substantial sum of money at very short notice, which is invaluable when looking to pay a deposit on a property at auction.
What types of bridging loans exist?
If you are looking to take a bridging loan, there are two types of loan to consider:
Open bridge loan
Open bridge loans are effectively open-ended, meaning they have no strict end date. If you choose to take out an open bridge loan, you can pay it back when you have the funds to do so. Commonly, this type of bridging loan lasts for up to a year, though it isn’t unusual for them to last even longer. Given the flexibility of this type of loan, it is usually more expensive than its more strict counterpart, the closed bridge loan.
Closed bridge loan
Unlike an open bridge loan, this type of loan has a fixed end date. Generally, when taking a closed bridge loan, you will have an idea of when you will have funds available, which will double as the date of repayment. Closed bridge loans most often short-term, with repayment expected in only weeks or a few months.
Choosing the right loan for you
There are a few factors to consider when looking to take out a bridging loan. Naturally, you will want to consider how much you want to borrow and for how long. Bridging loans can offer the recipient anywhere from £5,000 to sums into the millions. These loans can be taken for as short a time as a couple of weeks to a month or for as much as two years. Ensuring you have a clear picture of how much you need and for how long can save you money, as unnecessarily taking an open bridge loan will end up more expensive for you.
You will also need to consider the value of your property and whether you have a mortgage on it currently. The value of the property will determine the size of the loan, in addition to the rates you could get. Having a mortgage against your property will also affect the amount you can borrow, with a larger mortgage meaning a smaller loan. Secondly, it affects whether your loan will be a first charge or a second charge loan.
What are first charge and second charge loans?
First charge and second charge loans essentially refer to the order of priority when it comes to repayment. If you take out a bridging loan, the lender will determine a charge to whatever you use as security. In the event you cannot repay your loans and have property seized, the funds from the seized property will be used to pay off your loans, starting with first charge loans.
First charge loans
This refers to loans that are the only outstanding loan secured against a particular property. The most common example of a first charge loan is a mortgage against a house, but if you don’t currently have an outstanding mortgage, then any other loan can have this status.
Second charge loans
This refers to loans that are secured against a property that already has loans secured against it. To secure a second charge loan, the lender will typically need to get the permission of the first charge loan lender before they can also lend against the property.
Bridging loan interest rates
Bridging loans do not differ from other types of loans when it comes to interest rates – they will either be fixed or variable.
Fixed interest rates are simple, as the interest remains the same from the start of the bridging loan until the finish.
Variable rates, on the other hand, mean that the interest rates are able to change. When you first take the loan, the lender will set an initial rate. However, as the interest rates change, the amount you will need to repay can change too.
What are the costs of taking a bridging loan?
One of the most important points to consider when looking to take out a loan is what it costs you. With bridging finance, the main costs to be aware of are the interest rates and fees.
Interest rates
Compared to other loans, the interest rates on bridging loans can be on the expensive side, usually falling somewhere within the 0.4% to 2% realm. Of course, the actual rates will depend on the lender you borrow from.
While other loans typically charge an annual percentage rate (APR), bridging loans will tend to charge their rates monthly, as they are meant for the short-term. Minor differences in interest rates can be much more costly because of this.
In addition to monthly, bridging loan interest rates can be charged in two other ways – deferred or retained.
Deferred
Sometimes referred to as rolled up, this charge will require you to pay all of your owed interest in one lump sum at the end of your bridging loan. As you pay your interest all at once, you will not be required to pay any monthly payments.
Retained
By choosing this type, you can borrow the interest you will owe for an agreed amount of time, repaying this second loan at the end of your bridging loan.
Depending on your lender, you might be able to choose a mix of these types of interest payments.
Fees
In addition to interest rates, there are a number of fees to consider, including:
- Exit fees, which refer to a fee should you want to repay your loan early.
- Valuation fees, which involve paying a fee to have the value of your property assessed.
- Arrangement fees, which is simply the payment of setting up the loan.
- Legal fees, which some lenders charge to cover their own legal fees.
You might find that lenders charge any number of these fees, or additional ones. It is important to ensure you have the full picture of what your chosen lender intends to charge.
Applying for bridging finance
Now you know what a bridging loan is, the next important step is how to get one.
Firstly, you will need to consider what you want in a bridging loan. Knowing how much you want to borrow and for how long is key to getting the best loan for you. Similarly, you will want to consider how your situation factors in. As discussed, having a mortgage will impact what loans you can take, as will the value of your property. To get the best, and more importantly, most cost- effective, having this information will be crucial.
Once you have the information you need, you should start looking for bridging finance with acceptable interest rates. There are comparison tables you can use to help you with this. Once you have found a loan you would like to take out, you will need to speak to a broker and apply, which can be done over the phone or online.
After you have sent an application, you will need to wait while it is assessed. Though it can vary, you should hear back within twenty-four hours. Assuming your application was successful, all you need to do next is wait for the money to be sent to you. Again, the timing is variable, but you can expect to receive your funds within two weeks. As you can see, there is not much to it.
Where can you get a bridging loan?
You have a range of options available to you when looking for bridging finance. Most banks will offer this service to you, especially major, international ones. On the smaller end, there are many lenders that specialise in offering bridging loans as a service, with comparison sites existing solely to filter through these companies to get you what you need. Alternatively, you could contact a loan broker to have a more tailored and personal service, though expect to pay a higher fee than the alternatives.
Can you take out a bridging loan with bad credit?
In short, yes, it is possible that your application would be considered by many lenders despite a poor credit rating, however, it does carry its downsides. Most importantly, as a lower credit rating indicates higher risk, you would be more likely to have a higher interest rate, making it more costly for you. Additionally, you might find that some lenders are not willing to offer you the best loans and rates.
Should you seek out a bridging finance?
As with anything finance related, the answer to this depends on your personal circumstances. A bridging loan can get you a large sum of money very quickly, with a straightforward application process too. You have options available to consider, allowing you to take a loan that best suits your needs. However, compared to other types of loans, bridging loans have a set of steep interest rates, in addition to further fees, and are secured against your assets. As you stand to lose your assets in the event you cannot pay back the loan, there is a great deal of risk with this type of loan. If, despite these risks and downsides, you need quick funding that you think you can repay, then bridging loans could be a good option for you.