It’s no secret that bridging loans have seen a significant uptick in use as of late, especially to purchase property. Bridging finance has a host of benefits that make it a perfect tool for this purpose. Bridging loans can raise a large sum of money quickly, with a great degree of flexibility. This makes it a perfect tool for use in the property development industry, given its highly competitive market.
That said, although bridging loans are undeniably useful, they are admittedly still a niche form of finance, one that isn’t widely available amongst traditional lenders. Understandably, this has led some property developers to ask, “Are bridging loans safe?”. In this article, we will answer this very question, delving into how bridging loans work, and outlining the risks of using them. Let’s get started.
What is a bridging loan?
Bridging loans are a type of finance that fall under the umbrella category of secured finance. This means that, unlike some other loans, they require assets to be used as collateral to essentially guarantee the loan. This requirement of collateral is responsible for the many strong benefits afforded by bridging loans; as lenders don’t need to worry as much about a borrower’s ability to repay, they can expedite certain processes and lend more money.
In addition to being a type of secured loan, bridging loans are very much a short-term solution. Most bridging loans last around 12 months, though some do fall on either side of this time frame. As such, most borrowers do not use bridging loans as a be-all-and-end-all, and instead use them to “bridge the gap” between purchasing an asset and implementing a long-term solution.
How does a bridging loan work?
Bridging loans work by leveraging already owned assets, most often equity in a property, to raise considerable sums of money. It is an option often used in place of traditional finance tools, such as a mortgage, either because a borrower cannot qualify for such loans immediately, or because they are too inflexible. Bridging loans do not suffer from these shortcomings, and so prove to be a viable alternative indeed.
In practice, borrowers looking to purchase a new home without traditional finance can do so by securing a bridging loan against the equity in their current home. Essentially, this uses their current home as collateral for the bridging loan. In doing so, borrowers circumvent the usual processes required in loan applications. Credit rating, proof of income, and other such factors are not nearly as important as the asset’s value, though they will still play a part in risk assessment. Assuming the borrower has enough equity in their property, the application will be accepted, and a lien will be placed on the asset. This lien entitles lenders to seize the asset in the event borrowers fail to keep up with repayments, reducing the risk assumed by lenders.
Application approval
Once the application is approved, borrowers can expect to receive their funds within as little as 48 hours. They can then make a cash offer on their desired property, which the seller will likely receive well. Assuming the property is purchased, the borrower will then begin to pursue an exit strategy. In essence, this refers to a method of paying back the bridging loan. Oftentimes, borrowers will repay their bridging loan in one of two ways; the sale of an asset, usually the previous home, or refinancing the bridging loan with a long-term form of finance, such as a mortgage. In either case, borrowers would be wise to repay the bridging loan quickly, both to avoid risk and the comparatively high interest rates.
Are bridging loans safe?
Now for the most important question – are bridging loans safe? In short, yes, bridging loans are as safe as any other form of finance. This cuts two ways; on the one hand, bridging loans are very safe, and borrowers won’t be exposing themselves to unnecessary risks. On the other, bridging loans can be an issue for the unprepared. This largely comes down to what kind of bridging loan you use, and how much research you do into your lender.
There are two types of bridging loans – regulated and unregulated. Regulated bridging loans are exactly that, and borrowers enjoy protections from the FCA and can borrow from trustworthy sources. For example, though few openly advertise the service, many banks offer regulated bridging loans to those that ask for one. Using a regulated bridging loan exposes the borrower to very little unnecessary risk, even if you don’t rigorously vet your lender beforehand. However, it is much more restrictive than its counterpart.
Unregulated bridging loans are much less stringent in their application process. This allows borrowers to take out large sums of money relatively easily, with the loan agreement being much more flexible. However, the FCA does not govern unregulated bridging loans, and borrowers must do their due diligence to ensure they aren’t scammed. If you decide to take out an unregulated bridging loan, it is strongly suggested that you carefully vet your lender. If anything goes awry, you likely won’t be able to receive any help from authorities, and your money will be gone for good.
Disadvantages of using bridging loans
Although unregulated bridging loans pose a risk of a more legal nature, bridging loans can be a risk for certain borrowers. As we mentioned, lenders will place a lien on collateral assets, entitling them to seize said assets if borrowers can’t repay. Naturally, this exposes borrowers to the risk of losing their assets, which could be manageable for borrowers with secured finances. However, it could be a severe problem for borrowers in an unstable financial position. The short-term nature of bridging loans further accentuates this problem, as a full repayment must be made within roughly a year. Additionally, borrowers must make substantial interest payments, which could be as high as 20% for some business bridging loans. For borrowers facing financial difficulty, this risk may not be worth taking.
Wrapping up
All in all, bridging loans are a safe and viable form of finance. They are particularly useful when purchasing property, whether it be for commercial or private reasons. This is due to the many benefits of bridging loans, most notably their flexibility and speed. However, bridging loans have their risks, which could be a deal breaker for borrowers with unstable finances. As such, it is important to carefully consider your situation and obtain professional advice before you act.