Pros and Cons of Bridging Loan – Overview, Uses & Types – 2021

Bridging Loan Explained 2021 - Bridging Finance

There are several pros and cons of bridging loan when compared to other types of borrowing. Let’s take a close look at the bridging loan overview, types and uses.

Bridging loan is a short-term debt designed to bridge the gap between two situations, usually the purchase of a property before another sale. It is also known as a swing loan or caveat loan. In recent years a great expansion and growth have been seen in the bridging loan market of the UK.

However, some people still do not know what exactly is bridging finance and for which purpose they can use it. Another important thing that you may want to know is the benefits and drawbacks of bridging loans.

In this article, we are describing the uses of bridging loans and their pros and cons so that it can be easier for you to decide whether you should take out this loan or not.

Bridging Loan Overview

what are bridging loan

A bridging loan is a short term interest-only loan that is used to fund purchasing of a property. People also take out this type of loan to fund pending property purchases. It is easier to explain bridging loans with a practical example.

Suppose a family wants to move to a new or bigger home, they have found the right home for them, but the sale of their existing property has just fallen through. Now, if they do not commit to buying a new home, they are in danger of losing it. In addition, they already committed upfront payment for a survey, mortgage and other fees.

bridging loan can be a perfect solution in such situations that allow them to complete the purchase of a new home while they are trying to sell their current home. 

Bridging loans are secured loans, and you have to use your property as collateral until you repay the loan amount. Bridging finance is different from mortgage loans, and the primary difference is due to loan terms.

A standard bridging loan has a loan term between one to 18 months, while a mortgage can stretch up to 30 or 40 years. Normally, people use bridging loans when it is not possible to secure a mortgage loan.

Pros And Cons Of Bridging Loan

Pros and cons of bridging loan M

Pros Of Bridging Loan

There are a number of benefits of bridging loans when compared to other types of borrowing. Let’s take a close look at the benefits that you can get from bridging loans.

1. Quick To Arrange

When a large sum of money is required, you think of taking out a business loan or a commercial or residential mortgage. But all these facilities can take weeks or even months to arrange. In contrast, bridging loans are fast to arrange. Sometimes your loan application is approved within 48 hours. Moreover, commercial bridging loans are mostly unregulated and are extremely fast to arrange compared to other loans. As there is no regulatory burden, lenders are free and fragile to approve loans for property investors where deals depend on the availability of funds the speed of finance. 

2. Flexible Lending Criteria

There are several bridging loan providers in the UK, each with its own unique lending criteria. Usually, bridging lenders are not concerned with the affordability, credit history or income of the borrower. However, they are concerned with the value of the property you are using as security and the exit strategy. It is the method through which a borrower plans to repay a bridging loan. 

3. Easy Repayments  

In traditional borrowing, you have to pay an interest rate, usually on a monthly basis. While in bridging loan, the repayment of interest rate can be catered according to borrowers needs. You can choose to repay it monthly or at the end of loan terms. Usually, the interest is repaid as “retained interest“, which means the interest cost is added to the total amount borrowed. It is more beneficial and affordable for companies that are concerned about ongoing cash flow.

4. All Types Of Properties Can be Used As Collateral 

The borrowers can secure against any type of propertyincluding flatsshopsapartmentsmixed-use propertiesofficescomplexes or care homes. You can also use a property as a security if it is in poor condition or considered unsuitable for a mortgage. Moreover, if you want to take out a huge sum of money, you can use more than one property as collateral to take out a loan. 

5. Can Be arranged As 2nd Or 3rd Charge

Mortgage loans are usually available as a first charge loan, while you can take a bridging loan as a 2nd or 3rd charge loan. It means bridging finance can sit behind loans that are already in place. 

6. Available For Any Purpose 

One significant benefit of bridging finance that attracts borrowers is it can be used for any legal purpose. At the same time, traditional loans limit borrowing for specific purposes and do not offer any flexibility. As long as you have an intelligent exit strategy, lenders do not mind for which purpose you will use the money. Thus there is a lot of flexibility and ease when it comes to bridging loans. 

6. Available As No Status Loan

Most traditional property and business loans require a good credit score along with concrete security. However, no status bridging loans are available in the market that only focus on the potential profit of the deal. Thus, individuals who can not qualify for other forms of finance can also get funding through bridging finance.

 7. You Can Get Actually 100%

As long as you have sufficient security in place, you can get a 100% bridging loan. However, only a specialist group of lenders offer this type of loan, so you have to check with your lender whether they are offering a 100% bridging loan or not. 

8. Usually No Exit Fees 

The majority of bridging loan lenders earn profit through arrangement fees and interest rates. It prevents borrowers from paying heavy exit fees if they want to make early repayment of the loan.

Cons Of Bridging Loan

Along with a number of benefits of bridging loans, there are some disadvantages that you should keep in mind before availing of such finance.

1. High-Interest Rates

Bridging loan rates are usually higher than the standard bank loans. It approximately ranges from 1 to 1.5% it means it will be 12.68% to 19.5% per year. On the other hand, the annual interest rate on traditional mortgages is usually 5%. From this comparison, you can see how costly a bridging loan is

2. Currently Unregulated 

Bridging loans for residential properties come with protections and regulations similar to conventional property loans. However, commercial bridging loans are currently unregulated in the UK. No doubt it speeds up the approval of loan applications, but the borrowers do not have any resources for the protection of FCA. 

3. A Number Of Fees 

When you take out a bridging loan, there are a number of fees that will add up to the cost of a bridging loan. Usually, you have to pay arrangement fees that are around 1.5% of the loan amount. Other than that, you have to pay a broker feeadministration feelate repayment feevaluation fees and some legal fees. All of these changes increase the cost of borrowing. 

4. Widely Varying Terms And Rates 

Unlike traditional mortgages, bridging loan rates and terms vary widely from lender to lender. Furthermore, some lenders only offer loans through brokers; it means you can not access lenders offering low rates even if you did your due diligence. 

5. Chances Of Repossession 

You need to use your valuable asset (property) as security to take out a bridging loan. It is impossible to qualify for a loan if you do not have a property with enough equity to use as security against the loan amount.

If you fail to repay the loan amount on time, the lender has a right to sell your property to get the loan amount. It means there are chances of repossession of your property. 

Types Of Bridging Loan

types of bridging loan

There are two types of bridging loans that you should know as a potential borrower.

  • Open Bridging Loan
  • Closed Bridging Loan

Open Bridging Loan

  • This type of bridging loan does not have any fixed repayment date; however, usually, you have to pay the loan amount within one year.
  • This financial instrument does not depend on the final exit strategy of the borrower.
  • Open bridging loans are taken out by borrowers who intend to repay the loan by selling an existing property, but the property is not yet sold.
  • This type of loan carries more risks for borrowers because there is no repayment date and more chances of default.
  • That is why many lenders avoid such types of loans, and if approved, you have to pay a high-interest rate.

Closed Bridging Loan

  • Closed bridging loans have a fixed repayment date and require a viable exit strategy when you apply for a loan.
  • This type of loan is best for borrowers who have already exchanged contracts for the sale of their property and know exactly when the funds will become available.
  • In addition, closed bridging loans carry fewer risks compared to open bridging finance because borrowers and investors are assured of repayment by the sale of the property.
  • Due to these reasons, lenders approve this loan in a short time, and they will also charge a lower interest rate compared to an open bridging loan.

Uses Of Bridging Loan

Uses of Bridging Loan

Bridging loans are a great alternative to mortgages for individuals and businesses who want to purchase a property but need quick funding. Most commonly, bridging loans are used by property investors to bridge the gap between property purchase and arranging long term finance.

Other than that, there are many reasons for which a bridging loan can be used.

Some of the uses of bridging loans are as follows:

1. Maintaining Place in Property Chain

When you are looking to purchase a property but waiting for funds to become available by the sale of existing property, it may take a long time to complete the sale of a property.

During this time, you will need a short term loan to bridge the gap and proceed with the purchase. You have to repay the loan amount after the sale of your property. This is the most common and traditional use of bridging finance.

2. Refurbishment Or Renovation

Sometimes a property is considered unsuitable for a mortgage, for example, if it is in poor condition or when a buy to let or residential property does not have a proper kitchen or bathroom.

Bridging loans are available on such properties, which are unsuitable for securing a mortgage. Moreover, some property investors or homeowners want to improve the value of their property before the sale.

Therefore, they can take out the bridging loan for the renovation of a property so that they can get a good sale value.

3. Property Purchase At Auction

Auctions are a great opportunity for property investors or landlords who want to expand their portfolios. At the auction, properties are usually sold below their market value, but it is a time-limited opportunity.

Typically you need to pay a 10% deposit on that day and the training amount within 28 days. Bridging loans are set up quickly and can be used to purchase properties at an auction.

4. Business Cash Flow Problem

Businesses can use bridging loans to fulfil their current financial needs. Cash flow problems can arise anytime when running a business. 

Business owners take out bridging loans for a number of purposes, such as for purchasing new equipment or paying daily wages.

5. Refinancing

Refinance means when you take out a loan to repay your existing lender. A bridging loan can help you to cover payment gaps when you are facing delays for any reason.

In this way, it also protects you from the risk of repossession. You can take out a bridging loan to make your loan payment and protect your property from sale. 

6. Tax Payments

Due to quick arrangements bridging loans can be used to pay tax bills on time and avoid penalties.

Alternatives To Bridging Loan

Alternatives To Bridging Loans

Although bridging finance is a specialist type of funding that provides the best borrowing method in terms of speed and cost, it is always better to explore all the available options.

For example, if you are taking out a bridging loan for repayments of your mortgage, you must talk to your mortgage lender before taking out a bridging loan.

It might be possible that your lender offers you another date for repayment or lower repayments until your financial situation improves. 

If you are trying to sell your property but during this time, you find a new home. Instead of taking out a bridging loan, you can change your current mortgage to buy to let mortgage and rent out your property meanwhile searching for a good buyer.

You should need to do your homework to know how much rental income you need to cover the cost of your mortgage. Businesses can take funds through invoice financing or asset refinancing rather than taking out a bridging loan.

Other alternatives of bridging loans include commercial mortgage, development financesecured loans and asset loans

Conclusion:-

Bridging loans offer a number of benefits, but they also have some drawbacks. Thus, before getting into a bridging loan, you must look at both positive and negative aspects and check with at least four to five lenders. This way, you can secure the best deal for yourself.

Now that we have described the benefits and drawbacks of bridging loans, we hope that now you can make an informed decision on whether a bridging loan is the right option for you or not.