One of the defining characteristics of bridging finance is speed. Bridging loans are capable of raising substantial sums of cash quickly, allowing borrowers to obtain an asset in a short space of time. In the property development industry, this speed is invaluable. However, while this speed does benefit borrowers in some ways, it can equally pose a notable drawback. Bridging loans have a short repayment term, requiring borrowers to make a full repayment often in as little as a few months. To do so, and to avoid any issues that arise with late repayments, borrowers should have a reliable repayment plan before taking out a bridging loan.
In this article, we will break down the bridging loan process, how it works, and what methods of repayment are available to borrowers.
What is a bridging loan?
Bridging loans are a type of secured loan that aims to “bridge the gap” between a purchase and a long-term solution. Given this goal, bridging loans are very short-lived, typically lasting no more than a year, and with many lasting only a few months. Borrowers will be expected to make a full repayment before this time, using one of the methods we will discuss later.
As bridging loans are a type of secured loan, borrowers must put forward assets to be used as security. During the application process, borrowers must submit assets to secure the loan against, along with a professional valuation to ensure the assets are of sufficient value. Assuming the assets are appropriate, the lender will place a lien over said assets. In doing so, the lender formally secures the loan against the assets, and becomes eligible to seize the assets should the borrower default. This poses a double-edged sword: while the borrower is exposed to a greater level of risk than with other loans, this requirement of collateral allows bridging loans to boast their main advantages.
How do bridging loans work?
Bridging loans function quite similar to many other forms of finance, especially secured finance, though with a greatly expedited application process. To obtain a bridging loan, borrowers must use one of two sources: a traditional financial institution, such as a bank, or a private bridging loan lender. The former will often have to be asked, as banks don’t tend to openly advertise bridging loans in the same way they do their other products. The latter will likely have to be found using lending hubs, which specialise in introducing borrowers to suitable lenders. Once a suitable lender has been found, an application can be made.
Applying for a bridging loan is quite straightforward, especially compared to alternative forms of finance. The application process is fairly brief, requiring some of the usual information points present in other processes, such as proof of identity, proof of income, and credit score. While these latter two points influence the success of an application, the main factor at play is the value of assets put forward as collateral. In most cases, assets of sufficient value, with a professional valuation to back them up, will result in a successful application. Once the loan agreement has been signed and a lien placed over collateral assets, the requested funds will be released typically in mere days.
With the funds released to the borrower, the desired asset can be purchased with cash. This form of offer is highly appealing to property sellers, putting borrowers in good stead should they aim to purchase a new property. Once the desired asset is purchased, the next step is repayment, which should be made quickly to avoid mounting costs.
Costs of a bridging loan
Bridging loans can become quite expensive indeed. This is often primarily due to interest payments, which are notoriously expensive compared to alternative forms of finance. Borrowers can expect to pay interest rates within the 6-10% range, depending on the chosen lender. As bridging loans are usually quite large, this can lead to a hefty sum in interest over a short space of time.
In addition to comparatively high interest rates, bridging loans come with several costs, though the specifics can vary from one lender to another. One of the more common costs is a closing cost, which must be paid at the end of the loan. This closing cost can be low, or can be up to around 3%. Some lenders may also apply early exit fees should the loan be repaid before the end of its term. Borrowers can also expect to pay an appraisal fee for assets, administration fees, and a loan origination fee in some cases. Note that credit scores can affect these rates and fees, with better scores leading to cheaper bridging loans.
Repaying a bridging loan
Depending on circumstance, borrowers have some flexibility in how they repay their bridging loan. Repayments can typically be made in one of two main methods: the sale of an asset or the refinancing of the bridging loan. The former is a solution often utilised by property developers purchasing a new property for their portfolio. Oftentimes, they will secure their bridging loan against a property up for sale, with the proceeds of said sale going to repay the loan. Ideally, the old property will be sold shortly after the new one is purchased, keeping interest payments to a minimum.
Refinancing is the second major method of repaying a bridging loan. Rather than disposing of an asset, this method requires borrowers to cover the cost of their bridging loan with another loan. This is often used in cases where borrowers purchase a new property, but cannot afford to sell an asset to raise funds for repayment. The refinancing of an existing bridging loan is most commonly done using a mortgage, but any loan capable of raising the necessary funds is sufficient.
Wrapping up
Refinancing a bridging loan can be surprisingly simple. It is an option often used by property developers and those seeking to buy their new home alike, requiring the same process as obtaining a mortgage. Should a mortgage be unattainable or otherwise insufficient, borrowers may use another form of finance, assuming they find one capable of raising the necessary funds within the required timeframe. Due to the ease of refinancing as a method of repayment, bridging loans are a remarkably accessible loan, allowing many borrowers to enjoy the outstanding benefits afforded by these loans. However, bridging loans do pose a level of risk unmatched by certain other options, especially for those in a rocky financial position. As such, it is vital you seek professional advice before taking action.