Bridging loans are a form of finance that has seen a significant uptick in use over recent years, particularly by prospective homebuyers and property developers. Despite being a somewhat niche and novel form of finance, bridging loans have considerable advantages. Speed and flexibility are the two main advantages, both of which are responsible for the increase in popularity of bridging loans. However, although certainly a powerful tool, bridging loans are not all positive. It has its own set of risks and downsides, which should first be understood before taking action. The question is, are bridging loans risky, and do the benefits outweigh the risks?
In this article, we will answer this question, detail the risk mitigation strategies you can employ, and give you the information you need to get a bridging loan without opening yourself to unnecessary risk. Let’s get started.
What is a bridging loan?
Bridging loans are a type of secured loan that excels at swiftly raising large amounts of capital. This speed is reflected in the timeframe of bridging loans; namely, they are brief, with the average bridging loan term lasting roughly 12 months. While this brief timeframe can be quite restrictive, bridging loans are intended to be a short-term solution, aiming at bridging the gap between a purchase and the establishment of a long-term financial solution. Generally, bridging loan lenders will either repay the debt in full through the sale of an asset, or obtain a long-term financial solution such as a mortgage.
Are bridging loans risky for borrowers?
The main draws to bridging loans are their speed and flexibility. These advantages make it an ideal solution for seizing opportunities that arise in an auction house, or on the property market as a whole. However, these advantages come at a cost. As we mentioned, bridging loans are secured loans, meaning they require the use of collateral assets. When taking out a bridging loan, it will be secured against your assets of sufficient value. This allows your lender to place a lien on these assets, entitling them to repossess the asset or assets in the event you default. The lender will only be able to repossess assets equal to the outstanding sum of the loan.
For this reason, bridging loans can prove to be a risky decision for borrowers in an unstable financial position. Being unable to make repayments can lead to losing the assets you put up as collateral, which could have a ripple effect in other areas of your life. Losing a car, for example, could impact your commute and, therefore, your career. Furthermore, bridging loans are more expensive compared to other types of loan, typically demanding more in interest payments than others. While the strain of higher interest payments can be mitigated somewhat by choosing a more suitable method of paying interest, such as deferred interest payments, it can still be difficult to keep up with repayments. As such, bridging loans do constitute a fairly high level of risk for those in a precarious financial position.
Risk of unregulated bridging loans
Every bridging loan will fall under one of two categories – regulated or unregulated. Regulated bridging loans are considerably less risky than their counterpart; trusted lenders provide them, they are regulated by the FCA, and have more rigid criteria that ensure those that cannot hope to repay their chosen loan cannot obtain it in the first place. However, these qualities are not shared by unregulated bridging loans.
Unregulated bridging loans are essentially the opposite. True to its name, this category of bridging loan is unregulated by the FCA. This exposes borrowers to more risk, as they will not enjoy the protections and avenues of legal recourse provided by the FCA. This risk is magnified by the providers of unregulated bridging loans; these lenders are generally private individuals, small organisations, or hubs, none of which can provide the same trustworthiness as traditional lenders.
As they are unregulated, it is easier for unscrupulous lenders to market their unreliable services to prospective borrowers, without the threat of a legal authority to crack down on their activities. As such, the responsibility to make sure their lender is reliable falls to borrowers, though the risk is never nil. In exchange for this risk, unregulated bridging loans are typically much easier to obtain than their regulated counterparts; the application process is swifter, application criteria less stringent, and terms can be more flexible. Whether this benefit is worth the risk is for you to decide.
How can I minimise risk when taking out a bridging loan?
As we have mentioned, bridging loans have a fair few risks, especially for borrowers that aren’t in the most secure of financial positions. All this being said, there are several strategies you can use to mitigate these risks, allowing you to enjoy the many benefits of bridging loans without being exposed to any serious risk.
When attempting to mitigate bridging loan risk, the first thing you should do is steer clear of any untrustworthy lenders. This sounds obvious, but it can sometimes be difficult to tell which lenders are above board and which aren’t. The best way to weed out unreliable lenders is to stick with regulated bridging loans, though this might mean you can’t get exactly what you had in mind. Failing that, make sure you thoroughly research any lenders you consider borrowing from. Obtaining the advice of a professional can help with this, if you have the opportunity to do so.
The second most important risk mitigation factor is your exit strategy. This refers to how you will pay off your bridging loan once payment is due. For example, refinancing to pay back your bridging loan, or selling an asset, are both viable exit strategies.
Finally, making use of the flexibility of bridging loans is a good idea. Specifically, you should consider which interest repayment plan would be most suitable for you, and search for lenders that accommodate it. Rolling up your interest into the loan, with the full sum to be paid at the end of the term, makes missing monthly repayments a non-issue. However, this will mean your overall sum will be greater when repayment rolls around.
Wrapping up
All in all, bridging loans are not a dangerous form of finance, provided you are willing to do the work to reduce the risk you assume as a borrower. Bridging loans can be expensive and result in the loss of assets, though these risks are more than avoidable, provided you don’t enter an agreement blindly. Doing your research and obtaining professional advice will help you mitigate risk, allowing you to enjoy the benefits of bridging finance, regardless of how you intend to use it.