Bridging loans are an alternative form of borrowing compared to bank loans, which have a variety of unique advantages and applications. For an explanation of how bridging loans function and how they may benefit you, read on.
What is a bridging loan?
In short, a bridging loan is a short-term method of borrowing where physical assets are put up as security. They typically have a term of 12 months, though it can be anywhere from 1-18 months. Depending on the lender, the term may be extended even further.
While bridging loans have a range of applications, they are most commonly used to purchase property. The application process can be completed very quickly, and the interest is usually due at the end of the term, making it a good option for property developers and homebuyers alike.
How does a bridging loan work?
Unlike other types of loans, successfully applying for bridging loans is not dependent on credit ratings and annual incomes. This is because bridging loans are tied to physical assets, which determine how likely you are to get a bridging loan and the overall value of the loan.
Let’s take home buying as an example. Say you want to buy a house for £300,000 and intend to pay a deposit of £30,000 and take the rest out in a mortgage, but you do not have enough savings to make that deposit as you are waiting for your current home to sell. In this instance, you could opt to take out a bridging loan to ensure you can purchase the house without having to wait for the sale of your old one.
You would be required to secure the loan against your assets, which in this case could be the house itself. Bridging loans generally roll up the interest into the final amount due at the end of the term, meaning you can settle into your new home without worrying about interest payments. Once your old house sells, you can pay back the bridging loan.
How can a bridging loan be used?
Bridging loans can be used in several ways, one of the most notable being purchasing property. As bridging loans are tied to physical assets, the value of the loan can be as high as the millions, provided you have the assets to back it. They can be secured against an array of properties and land, making them especially useful to property developers.
Whether you intend to purchase properties for resale, or rental purposes, bridging loans can help finance your plans.
While bridging loans are particularly useful for making property purchases, the applications do not end there. In addition to funding property development, restoration, and auction purchases, they can assist with difficult situations, like divorce settlements or to prevent repossession.
Advantages and disadvantages of bridging loans
Bridging loans have several major advantages, most notably speed and ease, however, these advantages come at a cost. To ensure you make the right decision when looking to borrow money, it is important to consider the advantages and disadvantages before taking any actions.
Advantages
● One of the biggest advantages of bridging loans is speed. Oftentimes, you can complete the application process and have the money in hand all within two weeks. This can make bridging loans an excellent option to consider for property developers looking to make purchases from an auction.
● As bridging loans require property or assets to be put up as security, they can sometimes be of the entire value of the property you are looking to buy. This can be especially true for properties selling below market value.
● There are fewer restrictions and barriers when applying for bridging loans. Whereas other methods of borrowing are typically unwilling to lend money for uninhabitable houses. Most bridging lenders will be happy to. Additionally, as the value of the security and exit strategy are the most important factors for bridging loan applications, a poor credit rating or lower annual income is not nearly as important.
● Interest payments are generally not due monthly. Instead, they are rolled into the end of the term, along with the loan repayment. This can help reduce the pressure of moving into a new home by taking away the stress of looming debt repayments.
Disadvantages
● Compared to other loans, bridging loans are expensive. Interest rates are notably higher than traditional bank loans, which can make them a poor choice in the long run for some.
● Bridging loans are risky, and can have serious consequences if you cannot repay what you owe. Should you fail on your repayments, you will likely face even higher costs, and have the assets you put up as security seized. This risk is further increased by the short length of bridging loans, meaning you might not be able to get your finances back under control should things go wrong.
When applying for any loan, it is tempting to always aim for the lowest interest rates. However, this can be counterproductive. Some lenders will charge high hidden costs, often catching out those fixated on interest rates.
There is a range of hidden costs to look out for. Though the most common ones include high exit fees, high broker and valuation fees, and additions like fund management offers. Be sure to check all the costs involved in your chosen bridging loan to avoid any unpleasant surprises.
Are bridging loans right for you?
Depending on your circumstances, bridging loans could be a great borrowing option. Allowing you to purchase that perfect home, or add a new property to your portfolio. However, they do come with the noteworthy downside of being a comparatively expensive option. Which could serve to make a poor financial situation worse. To ensure you make the right choice for you, seek professional advice. Weigh how the pros and cons of bridging finance relate to your situation.