Bridging loans are a very powerful form of finance. They can be employed in a variety of industries for an even wider series of applications, and for personal purchases without any ties to business. While bridging loans are certainly useful in general, they are especially effective in the property development industry. The advantages of using bridging loans, namely their swiftness and flexibility, make them a prime choice for property developers looking for finance. But is it too good to be true? Do bridging loans have a number of risks that offset the strong advantages they offer?
In this article, we will answer these questions, break down how bridging loans work, and whether you should consider using one for your next project. Let’s get started.
What is a bridging loan?
Bridging loans are a form of secured finance that aims to provide a short-term financial solution. Bridging loans tend to be no more than 12 months in length, with most having much shorter terms. It is not unusual for a bridging loan to last only one or two months, though most bridging loan lenders will offer a variety of loans of varying lengths. True to the name, bridging loans are intended to “bridge” the gap between a purchase and a long-term solution, hence the rather short loan terms.
As bridging loans are a type of secured finance, they require physical assets to be used as collateral. Such assets can essentially be anything the borrower has available, from property to vehicles, though the asset used as collateral tends to match the asset being purchased. For example, if a borrower needs a bridging loan to purchase a property, they will usually use another property as security. Once assets are put forward for use as collateral, the lender will place a lien on them. This entitles the lender to seize said assets in the event the borrower cannot make repayments, up to the value of the loan that remains outstanding. Naturally, this means borrowers will expose themselves to a higher level of risk than with unsecured loans, and could make bridging loans dangerous for some borrowers.
Speed and flexibility
While using assets as security may be off-putting to some borrowers, this requirement is precisely where bridging loans derive their key advantages – speed and flexibility. Whereas many other types of finance will require borrowers to complete extensive, and oftentimes lengthy, background checks, bridging loans cut much of this loose. The usual factors are not viewed as highly in a bridging loan application, with the main emphasis being placed on the value of a borrower’s assets. Assuming the borrower has an accurate valuation at hand, bridging loan applications can be completed almost as soon as they begin. The value of collateral assets also determines how flexible a bridging loan can be; borrowers with high-value assets can take out much larger loans for longer, and vice-versa.
Also Read: Bridging Loan vs. Recast – Which Should You Use?
How do bridging loans work?
We’ve covered what bridging loans are, but how exactly do they work in practice? In short, they work much the same as most other loans, albeit with some differences along the way. Borrowers will go through an application process, which will be much faster than usual, and funds will be released upon a successful application. This can take as little as 48 hours to complete.
Once funds are released, borrowers are free to make their desired purchase. Assuming this is a new house, borrowers can make a cash offer, which a seller will likely view quite positively. Once the keys are exchanged, borrowers will then begin to repay the loan. While there are several ways to repay a bridging loan, the most common are to either refinance the loan with a mortgage or similar form of finance, or sell an existing asset to make a full repayment. However you choose to repay your bridging loan, it is important to do so quickly to avoid monthly interest and continued exposure to risk.
Pros and cons of bridging loans
Answering whether or not bridging loans are dangerous is essentially a balance between the pros and cons. Before we answer this question, let’s first consider what you stand to gain and lose from using bridging loans.
Pros of using bridging loans
There are several pros to using bridging loans, but we’ll focus on the most important. These are:
- Speed – Bridging loans are nothing if not fast. Provided you are willing to do a little bit of preparation before you submit an application, you can receive approval or refusal in a very short space of time.
- Flexibility – Bridging loans are about as flexible as they are swift. A wide range of loan amounts can be requested for varying lengths of time, and the money can be used for a vast array of applications. What’s more, there’s even flexibility in how you can repay the loan.
- Repayments aren’t always immediate – Following on from the last point, bridging loan repayments don’t always begin immediately. Depending on your lender, you might have a few months’ grace before repayments will begin.
Cons of using bridging loans
While bridging loans certainly have their pros, they have a few noteworthy cons to consider. The main ones are:
- Cost – Bridging loans are notoriously expensive. Not only can the interest rates be high compared to other types of loans, but the additional costs can make the final bill pretty hefty. You’ll need to carefully read over any contract to make sure you aren’t expected to pay more than you’re able.
- Your assets might not sell – If you intend to repay your bridging loan through the sale of an asset, you are relying on that asset to sell quickly enough and for a high enough price to repay the loan. If this doesn’t happen, you could be in a tough spot, and you’ll have paid a few months’ worth of interest for your trouble.
- Risk – This certainly isn’t unique to bridging loans, but it is worth mentioning. As bridging loans are secured loans, you will need to use owned assets as collateral. In other words, you must expose yourself to a certain level of risk from the get-go.
Are bridging loans dangerous?
With the main pros and cons of bridging loans listed, let’s answer the main question – are bridging loans dangerous? The answer largely depends on your financial situation. If you have a solid financial foundation, and are able to repay a bridging loan in full even if your initial repayment method falls through, then bridging loans are not dangerous.
However, if your finances are less than stable, and there is a very real possibility that you miss out on a month or two of repayments, then bridging loans could be dangerous for you. Jumping into bridging loans without adequate financial stability could result in important assets being seized, which will leave you in a far worse position overall.
Should you use a bridging loan for your next project?
All in all, bridging loans are a very useful form of finance, especially for funding property development projects. The benefits make bridging loans second to none, allowing you to seize any opportunity in the market the moment you see it. However, bridging loans can be dangerous for those without the right financial position. Exposing yourself to unnecessary risk can and does end poorly, and is often simply not worthwhile. If you are unsure whether bridging loans are right for you, be sure to seek professional advice for a helping hand.