Bridging loans have been widely used for a variety of applications, though they are used most commonly to fund the purchase of property. Both in the property development industry and private home purchases, bridging loans have been relied upon to close a great many deals.
Bridging loans are used extensively for the purchase of property due to their specific qualities and advantages. Arguably the most important, they allow property owners to secure a loan against their current property while they prepare to purchase another. This allows for a great degree of flexibility, both for commercial purchases, and personal ones.
Although bridging loans are commonly used and have an array of advantages, they are not always a perfect solution. Some cases can greatly benefit from the use of bridging finance, while others may need another specialised touch. For this reason, many prospective homebuyers and property developers wonder, “Are bridging loans a good idea?”.
In this article, we will answer this question, provide an in-depth look at how bridging loans work, and ensure you have the information to make the best decision for you. Let’s get started.
What is a bridging loan?
A bridging loan is an extremely short-term form of secured finance. It aims to “bridge the gap” between the purchase of an asset, and a more long-term form of finance. Because of this, most bridging loans last well under a year, with many having a term of only a few months.
While certainly short-lived, bridging loans are an exceptionally effective form of finance. They offer quick access to finance, a reasonable degree of flexibility, and a large loan value. This allows borrowers to react to changes in the property market swiftly, ensuring opportunities do not slip by.
How do bridging loans work?
Bridging loans function quite similarly to other secured loans. They require physical assets of similar value to secure the loan against, affording borrowers a variable loan limit depending on the value of their assets. This requirement of collateral effectively negates the need for traditional loan application requirements, such as credit ratings and proof of income, making for a speedy process. However, this does pose some risk for borrowers.
Once an asset is used to secure a bridging loan, the lender will place a lien on said asset. This lien legally entitles the lender to seize the asset in lieu of repayment, should the borrower ever be unable to make repayments. While this may not be an issue for borrowers with secure finances, borrowers on a less stable financial footing may expose themselves to considerable risk of asset seizure.
After the bridging loan is obtained, a property or other asset can be purchased, and the focus can shift to repayment. Generally, an exit strategy, otherwise known as a method of repayment, will be required during the application process. Most bridging loan borrowers use one of two exit strategies: the sale of an existing asset, such as a previously owned property, or the refinancing of the bridging loan. Both are viable methods of repayment, though which you should use depends on your situation.
When to use a bridging loan
Bridging loans can be used for a wide variety of purposes, though they are most effective at funding the purchase of property. This is true for commercial purchases and for buying a new home. Property developers can use bridging loans to quickly raise large sums of money as and when they spot new opportunities in the market. They can secure the loan against another property in their portfolio, and beat their competition to the punch. Equally, homebuyers can secure a bridging loan against their current home, using the funds to pay off an existing mortgage and cover a deposit, or make a cash offer outright. The bridging loan can then be repaid through the sale of the old home, or refinanced using a mortgage.
Pros and cons of bridging loans
Bridging loans have several notable advantages, but are not without their downsides. While the pros can outweigh the cons in many circumstances, this depends on specific factors and will not always be the case. Let’s take a look at the pros and cons of bridging loans.
Pros of bridging loans
Bridging loans have a number of pros that lend themselves well to purchasing property. The following are some of the most important:
- Fast access to finance – The most significant advantage of using bridging loans is the speed of the process. Applications are short, will be processed quickly, and often result in cash deposits taking as little as 48 hours.
- High-value loans – Bridging loans can be used to raise large amounts of cash. In practice, the effective limit depends on the value of your assets, and the ability of a lender to accommodate large loans.
- Flexible – Bridging loans are generally quite flexible. They are typically easier to obtain than most unsecured loans, have a wide range of applications, and even sport a few choices regarding repayment.
Cons of bridging loans
Equally, bridging loans have a few cons that are worth keeping in mind. The following are some of the most important:
- Comparatively high cost – Bridging loans are a more expensive option than many of their alternatives. They tend to have higher interest rates, and can also have additional fees that aren’t present in other loan types.
- Higher level of risk – Bridging loans require collateral, meaning borrowers assume more risk than unsecured loans. If a borrower can’t repay, lenders are entitled to seize collateral assets in lieu of repayment. If a borrower uses important assets as collateral, this can cause serious problems.
- Requires high-value assets or equity – As bridging loans require collateral assets, they aren’t an option for borrowers without sufficiently high-value assets or equity in a property.
Should you use a bridging loan?
All in all, bridging loans can be an incredibly useful form of finance. They offer fast access to substantial finance, which can be the difference between obtaining a dream home and missing out. Whether you should use one, however, depends on your circumstances. Bridging loans aren’t an option for everyone, as borrowers must assume a certain level of risk and must have assets of sufficient value. These two factors can be make-or-break, depending on your personal finances. As such, consulting a financial professional before taking action is advisable.