Bridging loans are a reliable form of finance commonly used in a range of industries for a variety of different purposes. Property development is an industry that most commonly uses bridging loans, due to the excellent benefits they afford. Chief among these benefits are speed, flexibility, and size, all invaluable benefits to a property developer.
While this applies to bridging loans as a whole, they are not a one-size-fits-all solution. Bridging finance is an umbrella term, referring to two categories of finance – open and closed bridging loans. In this article, we will discuss both of these categories, break down the specifics, and cover which might be best for you.
What is a bridging loan?
Bridging loans are a type of secured loan that specialises in providing a short-term service. Bridging loans seldom last longer than 12 months, with many falling well below a full year. While this might seem like a downside, they aim to “bridge the gap” between a purchase and a long-term financial solution. These solutions often come in the form of other loans, such as mortgages, or through the sale of assets. As such, long-term bridging finance simply isn’t necessary.
As bridging loans fall under the umbrella of secured loans, they require physical assets to be used as collateral. When purchasing property, this will usually require borrowers to use owned properties as their collateral assets. The requirement for collateral assets does increase the amount of risk borrowers must assume, but it is also the primary source of bridging finance’s benefits. Due to this requirement, the application process is greatly streamlined, resulting in a quicker and more accessible service. However, the specifics of this service vary somewhat between the two main categories – open vs closed bridging loans.
What are the differences between open vs closed bridging loans?
The main differences between the two types of bridging loans are exit strategies and how they affect the wider loan. Exit strategies are, in essence, the means by which a borrower will repay their bridging loan in full. All bridging loans need a viable exit strategy, though how important this is during an application varies between the two types.
Open bridging loans are more accessible overall, as they don’t require the borrower to have a clearly defined exit strategy before taking on the loan. However, closed bridging loans do have this requirement, as lenders must be able to clearly see how the borrower intends to make repayments. This could be through the sale of assets, refinancing, or the release of funds locked up in an investment account, to name a few examples. Before even considering an open bridging loan, borrowers should have a clear means of repayment.
Pros and cons of open vs closed bridging loans
Although very similar, both types of bridging loans have their pros and cons. While not wildly different from one another, these differences do impact how the two bridging loan categories work, and how well they might suit your situation.
Pros and cons of open bridging loans
Open bridging loans have a host of advantages. Some of these advantages are held in common with closed bridging loans, such as the speed with which finance can be raised, the high amounts that can be raised, and the excellent range of uses bridging loans can be applied. That said, by far the greatest advantage of using an open bridging loan is flexibility.
While all bridging loans are flexible, open bridging loans are especially so. The requirement of an exit strategy remains, but is not nearly as immediate as under closed bridging loans. This means that property developers or homebuyers looking to purchase a new property don’t need to close a sale on any old properties, or have another form of finance lined up. This flexibility can be perfect when attempting to seize potentially fleeting opportunities, such as the purchase of a dream home or a development opportunity brimming with potential.
Flexibility
However, this key advantage acts as a double-edged sword. Although it certainly does make a bridging loan more flexible, it comes with an equal increase in risk. Borrowers assume a much higher degree of risk without a secure exit strategy in place. At best, borrowers will end up paying relatively high interest rates for longer than would be ideal, diminishing profit margins or increasing the overall cost of purchasing a new home. At worst, borrowers might not be able to secure an exit strategy before the loan term ends. This is likely to result in the seizure of collateral assets in lieu of repayment, as is the case for any secured loan.
The additional risk is not exclusive to borrowers, however. Lenders also assume additional risk, as the lack of an exit strategy increases the likelihood of late repayments and the need for asset repossession. As these impact a lender’s finances, they may well avoid borrowers without an exit strategy in favour of those who have one.
Pros and cons of closed bridging loans
Closed bridging loans are the other side of the coin, largely mirroring the pros and cons of open bridging loans. In addition to the benefits and drawbacks of bridging loans as a whole, closed bridging loans are considerably safer than open bridging loans. Having a solid exit strategy beforehand gives you peace of mind, as it ensures you can fully repay your bridging loan when necessary. This has the added benefit of keeping costs down, especially if you can implement your exit strategy quickly. Lenders are also more likely to lend to you, as they also benefit from the lesser risk.
The counterpart to this lesser risk is more rigidity. Closed bridging loans aren’t as easy to obtain quickly, as a viable exit strategy must be in place beforehand. If you can’t close the sale of a property to serve as an exit strategy, or find another form of finance to cover repayments, then you will have to wait for a closed bridging loan.
Open vs closed bridging loans – which should I use?
Both open and closed bridging loans have their use cases and weak points. Open bridging loans are exceedingly flexible and can be obtained more quickly, though they come with a much higher degree of risk. Closed bridging loans are essentially the opposite, being less flexible but carrying a lesser level of risk. As such, it is vital that you consider your situation carefully, and seek professional consultation for advice before taking action.