Although still a relatively recent product, bridging loans have more than proved their worth in the finance market. They have been effective in a wide range of applications, from the purchase of land, to the funding of property renovations. While widely useful, bridging loans are particularly effective in the property development industry, largely due to a couple of key benefits offered by the loan. But, there is not one single type of bridging loan, causing these benefits, and thereby the most suitable applications, to vary somewhat. If you want to know how well a bridging loan could work for you, then you’ll need to consider both your situation and the benefits of the various types of bridging loans.
In this article, we will focus on two types of bridging loans – open-ended bridging loans, and closed bridging loans. We will provide an overview of both categories, break down how they function, and discuss what they can do for you. Let’s get started.
What are open-ended bridging loans?
An open-ended bridging loan is a form of bridging finance that has a repayment term akin to most other loans. Once an open-ended bridging loan has been approved, a term usually no longer than 12 months will be established. However, there isn’t a specific deadline beyond the end of the term, and the loan can be repaid sooner should the borrower wish. In some cases, lenders will even allow borrowers to extend the loan term, allowing for slightly later repayments. Many bridging loans are open-ended, as it offers a greater degree of flexibility.
Beyond the repayment term, open-ended bridging loans function like any other. They are short-term in nature, being used as a “bridge” between a purchase and a long-term form of finance. When taking out an open-ended bridging loan, borrowers will be required to use physical assets as collateral. This collateral can take essentially any form provided it is of equivalent value, though borrowers tend to match collateral assets with the assets being purchased. For example, borrowers purchasing property will likely use property as collateral.
Repaying an open-ended bridging loan is done using an exit strategy. Borrowers could use several different exit strategies, though three stand out as the most common. First, borrowers will repay their bridging loan through the sale of a previously owned property. This could be selling a previous home when purchasing a new one, or selling off a development opportunity once it has been renovated sufficiently. Second, borrowers can sell one or more assets that are not in the same category as the target asset. Third, borrowers can refinance the bridging loan using a long-term solution. In many cases, this takes the form of a mortgage, but any loan that can take the place of the bridging loan will suffice.
Pros and cons of open-ended bridging loans
As with any form of finance, there are pros and cons to be weighed before taking out an open-ended bridging loan. The following are some key pros and cons:
Pros of open-ended bridging loans
- Flexibility – Flexibility is one of the best draws to open-ended bridging loans. With one, you can raise large sums of money in a short space of time, without as rigid a deadline as with closed bridging loans.
- Speed – Due to the requirement of collateral, bridging loan applications tend to be much quicker than their counterparts, due to fewer checks being conducted. This is due to bridging loan lenders being more concerned with the value of collateral assets, rather than credit score, income, and other such factors.
- Fewer penalties or hidden fees – Open-ended bridging loans usually have fewer hidden fees and penalties, when compared to their counterparts. For example, open-ended bridging loans do not have the same late repayment fees present in closed bridging loans.
Cons of open-ended bridging loans
- Risk – Open-ended bridging loans require collateral, which in turn exposes the borrower to more risk than unsecured loans. If the loan cannot be repaid, then asset seizure is a possibility.
- Interest rates – Open-ended bridging loans, while cheaper in some regards, suffer from high interest rates. It is best to repay your bridging loan quickly, as a longer term will lead to higher costs.
- Loan value is tied to assets – The requirement of collateral is a double-edged sword. While it allows borrowers to take out high-value loans, this is only possible with equally high-value assets.
Also Read: Bridging Loan vs. Home Equity: Which Should You Use?
What are closed bridging loans?
Closed bridging loans are another category of bridging finance, referring to loans with a repayment date tied to the sale of an asset. This is the key functional difference between open-ended bridging loans and closed bridging loans, which results in several practical differences between the two. That said, the two loans work identically, aside from the difference in exit strategy.
While an open-ended bridging loan does require collateral, it has a time frame for repayment. Closed bridging loans have a very specific date in mind, based on the expected date of sale of the collateral asset. This usually happens when a sale has been agreed upon, but has been delayed or is otherwise not yet complete.
Pros and cons of closed bridging loans
Although closed bridging loans function very similarly to open-ended bridging loans, they have their own set of pros and cons. These are as follows:
Pros of closed bridging loans
- Lower interest rates – As closed bridging loans operate based on the assumption that a property will be sold, repayments appear more certain. This makes for lower interest rates, and a cheaper option overall.
- Loan value – Quite like open-ended bridging loans, closed bridging loans allow for large amounts of cash to be raised. This makes purchasing expensive assets, such as property, fairly straightforward.
- Approval rates – Compared to open-ended bridging loans, closed bridging loans have a higher approval rate. This is due to the perceived lower risk assumed by lenders, as they have a fixed date of repayment.
Cons of closed bridging loans
- Less flexible – As the repayment date is fixed, closed bridging loans aren’t flexible if things go wrong. If, for whatever reason, the collateral asset sale is not sold before the repayment date, then problems can arise.
- Costs – Closed bridging loans can be more expensive if you make late repayments. Late repayment penalties are costly, and can add up quickly.
Open-ended or closed bridging loans – which should I choose?
Ultimately, the answer to this question depends on your situation. If you can confirm a date of sale for your property, and want a loan with a higher approval rate, then a closed bridging loan may be a good idea. Conversely, if you aren’t certain when your property will sell and require a loan with a bit more flexibility, then an open-ended bridging loan may be the better option. As always, you must consider your situation’s needs and obtain professional advice before taking action.