When it comes time to purchase a new property, either for commercial reasons or as a private dwelling, sourcing a reliable form of finance is paramount. Bridge loans are commonly used for this purpose. Although a niche form of finance, bridge loans offer a number of advantages that make them perfect for purchasing or renovating property, and can even be used to buy a new home. While bridge loans are certainly a good choice, there are strong alternatives that may offer a better service in certain cases. One such alternative is a recast.
In this article, we will examine bridge loans vs. recasts, discuss how both work, and ensure you have the necessary information to make the best choice. Let’s get started.
What is a bridge loan?
Bridge loans are a part of the secured finance category. This means that bridge loans require physical assets to be used as collateral as part of the loan agreement. While this does pose an additional risk for borrowers compared to unsecured loans, it is largely responsible for the key benefits of bridge loans. As collateral is required, bridge loan lenders place much less emphasis on other factors, such as credit score or income. Having assets of sufficient value is the main thing that matters. This greatly expedites the application process, allowing bridge loans to be a swift and flexible form of finance.
How does a bridge loan work?
In practice, bridge loans aim to “bridge the gap” between the purchase of an asset or property, and a long-term form of finance. It is important to know that bridge loans are not a long-term solution, and instead are essentially a middleman that allows you to act quickly. When it comes to purchasing a property, this is invaluable.
As we mentioned, bridge loans require collateral assets as part of the loan agreement. When using a bridge loan to purchase property, one of the most common assets used is equity in an already-owned property, a home being one example. This equity will be disclosed during the application process, and in many cases, the loan will be secured against the property. Once the application is approved, funds can be released in as little as 48 hours.
With the funds secured, the borrower can then purchase their new home using a cash offer. This offer will likely be pushed to the top of the list, as sellers view cash offers favourably. Assuming the offer is accepted, the borrower will now move to pay back the bridge loan. This is typically done in one of two ways. The first is that the borrower sells their previous home, then uses the equity in said home to repay the bridge loan. If this cannot be done, then the second option is to refinance the bridge loan using a long-term form of finance. This is usually a mortgage, though it can be anything that gets the job done. With the bridge loan repaid, the borrower will begin to repay their long-term loan as normal.
What is a mortgage recast?
A mortgage recast is a feature in certain mortgages that allows borrowers to make a substantial lump-sum payment, which will then be factored into their mortgage recalculation. This results in the borrower saving money, as the interest they owe will be reduced due to paying off a significant portion of the mortgage. This can be done multiple times depending on if the mortgage has scheduled recast dates, and can be used to greatly decrease the amount of interest a borrower will owe over the course of the loan’s lifetime.
How does a mortgage recast work?
Mortgage recasts work simply by making a substantial repayment before the new amortization schedule arrives. In other words, making a large payment on your mortgage before the interest rates are recalculated will result in much lower monthly repayments than paying a fixed amount every month. Naturally, the main goal of doing so is to decrease the amount of interest payable, making the loan cheaper for the borrower.
When purchasing property, a mortgage recast can be a good option if you have a good amount of equity in your previous home. For example, say you sold your home for £250,000 and had £150,000 in equity. You purchase a new home worth £300,000, paying a 20% deposit of £60,000 and financing the rest through a new mortgage. You could then make a substantial repayment on your new mortgage immediately, greatly reducing the amount outstanding and the payable interest. In doing so, your loan will be cheaper and easier to repay.
Which is best – bridge loan vs. recast?
Whether you should use a bridge loan vs. recast is highly dependent on your situation. Both options have their pros and cons, but each has a scenario they specialise in. For example, a mortgage recast is especially useful if you have a good chunk of equity in your home and can make a large lump-sum mortgage payment upon selling. In doing so, you will greatly reduce the principal of your new mortgage, and lower the amount of monthly interest payments you’ll have to make. However, mortgage recasts are not as useful if you don’t have much equity or can’t make a large mortgage payment, and are certainly of little use for commercial purchases.
On the other hand, bridge loans can step in where mortgage recasts aren’t as effective. A bridge loan can help you make a cash offer on a property if you can’t find a suitable mortgage, or can help cover the shortfall and make a good deposit. Bridge loans can also be used for a wide array of purposes, including purchasing commercial property and development. Assuming you have a viable exit strategy, or a means of repaying the bridge loan, you can use it to cover almost any purpose. Moreover, bridge loans help you move very quickly, which is imperative in the property development industry.
All in all, you will need to weigh up your situation and what you need before you make your choice. As always, it’s a good idea to seek professional advice before you take action, and ensure you make the best decision for you.