Bridging loans are a type of short term loans that help you to buy a property before the sale of your existing property. They are used to finance the gap between when you want to purchase something but are waiting for funds to become available by the sale of another thing. Often bridging loans are used by people in the real estate business but you can take them for many different purposes. When you take out a bridging loan you have to use your property as collateral. When you think of taking out a bridging loan you have to learn a lot of things such as what is bridging loan, how it works and where you can get it. Read on to find out the answers to all these questions.
What Is A Bridging Loan?
A Bridging loan is also known as gap financing, swing loans and interim financing. Bridging finance is a type of interest-only home loan. Its value is calculated on the basis of equity in your current property. It provides you with immediate cash flow when you need immediate funding. A bridging loan has a very high-interest rate and is backed by collateral such as a property or business inventory. It allows you to fulfil your current financial obligations. These loans are short term and usually up to one year. Homeowners can use bridging loans for the purchase of a new home while their existing one is on sale.
How Does a Bridging Loan Work?
Many lenders are providing bridging loans in the UK. However, the amount that you can borrow varies from lender to lender. Bridging loans are available for both corporations and individuals and they can use them for different purposes. The amount you borrow is known as peak debt. The repayment is usually calculated on the basis of interest only and sometimes the interest is capitalised till your existing property is sold and is added to the peak debt. The loan is secured against your property. Unlike a mortgage, a bridging loan does not have any direct link to your income.
How Can You Repay A Bridging Loan?
Typically, a bridging loan must be repaid within a period of 12 months but the terms may vary depending on the lender you choose. Many people repay the loan amount with the money they got by selling their current property, but there are different options for repayment. The repayment of bridging loans are structured in different ways but usually, there is a balloon payment at the end. However, different lenders have different criteria for the repayment of the loan. It is important that you check the repayment method before taking out a bridging loan so that you can repay the amount conveniently.
Types Of Bridging Loans
Bridging loans are of four types and whilst they are all designed to provide short term financing, they can vary in terms of repayment and security. Let’s take a closer look at all types of bridging loans.
Open Bridging Loan
It is a type of bridging finance that is flexible and more suitable for borrowers who are uncertain about making repayment of loans. Open bridging loans do not have any fixed payoff date. In order to ensure the security of funds, bridging loan lenders deduct the interest from the loan advance. This type of loan is perfect for borrowers who are not certain about when the expected finance will become available. However, it is vital to remember that open bridging loans have high interest rates because lenders find such loans riskier.
- Closed Bridging Loan
A closed bridging loan is a form of finance that is available for a specific time frame. In such types of loans, the borrower is given a clear repayment date or an exit strategy. These loans have a higher acceptance rate because they give some type of certainty to the lenders about the repayment of the loan. These loans are also suitable for borrowers because of low-interest rates compared to open bridging loans. Some people know the exact date when their funds will become available, they can take out closed bridging loans and save some money in terms of interest rate.
First Charge Bridging Loan
In the first charge bridging loan, the lender can take the first charge over your property. When you take out such loans the lender adds a charge to your property that you are using as security. These charges set a priority of debts. In case of default, the first charge bridge loan lender will get the money first before the other lenders. First charge loans are where a bridging loan is the only loan secured against your property. These loans have less underwriting risk and low-interest rate as compared to the second charge bridging loans.
Second Charge Bridging Loan
In a second charge bridging loan, the lender takes the second charge on your property after the existing first charge lender. You need to take a second charge loan when there is already a mortgage or loan on your property. This type of loan allows you to raise funds without re-mortgage. You can take out a loan for a small period, usually 12 months. Second charge bridging loans carry more risk of default thus they have a high-interest rate. The lender who provides you with a second charge loan has the same rights of repossession as the first charge lender.
How Can You Apply For A Bridging Loan?
Here are some steps that can help you in finding the best bridging finance provider and also in the application process.
- The first thing you need to do is to decide the purpose you are taking out a bridging loan for, the amount you need to borrow and for how much time.
- Collect all the essential details about your current situation such as the worth of your property, do you have any mortgage, how much is the mortgage and equity in your property. All this information can help you find cheap bridging loans that meet all your needs.
- Shop around and make a price comparison to find the competitive market rates of bridging loans.
- Decide whether you want to take a loan through a broker or from a direct lender.
- Before taking a loan from the lender you must take a look at cost and fees and read the terms and conditions carefully.
- Apply by filling out an application form and wait for the approval of the application. Typically, It can take up to 24 hours.
- Once your application is approved by the lender you will receive the funds within a period of two weeks.
How Much A Bridging Loan Costs?
Though bridging loans help you to fulfil your emergency financial needs, they can be an expensive way of borrowing money. The cost of bridging loans depends on the interest rate and fees. The interest rate on bridging loans are usually high that can vary from 0.4 to 2% depending on the lender you choose. Bridging loans are short term loans and usually, interest rates are charged on a monthly basis rather than as an annual percentage rate. But it is not a restriction that interest rate is charged monthly. Most lenders give you the following three options to pay the interest rate.
Monthly: You can pay the interest rate monthly and the amount of interest is not added to your bridging loan amount.
Rolled up or deferred: you have an option to pay all the interest at the end of the loan term instead of paying monthly.
Retained lenders: give you an option to borrow for a predetermined period and pay it back at the end of the loan term.
Other than interest rate there are several other fees and charges that add to the cost of bridging loan. It may include arrangement fee, legal fee, repayment fee, administration fee, broker fee, valuation and exit fee. Therefore, you must keep in mind all these things before taking out a bridging loan so that you can decide whether you can afford to repay such a loan or not.
What Can You Use a Bridging Loan For?
There are situations when you find yourself in need of emergency cash. If you wait for funds to become available you may lose an opportunity to buy something or to invest in. A bridging loan can be a perfect temporary solution in such situations. You can use bridging finance in multiple circumstances some of which are as follows:
- Refurbishment Finance
Sometimes a property is not being sold because it is in poor condition or it lacks the basic necessities such as a kitchen or a bathroom. Bridging loans are suitable for property developers who want to refurbish a property to sell it at good prices. You can take bridging finance for refurbishment purpose and repay the amount upon sale.
- Maintaining A Place In Sales Chain
When you want to purchase a property but waiting for your existing property to sell so that funds become available. You can fill the gap by taking a bridging loan till the sale of your property is done. You can use the amount of bridging loan to buy a new property and can repay the loan after the sale of your previous property. It is the most common use of bridging finance.
- Property Auction
Auctions are a great place for spontaneity and opportunity, while it is both adventurous and exciting. Often it can mean that the buyers can purchase properties even when a montage agreement is not already in place. When you win an auction bid you have to pay a 10% deposit on that day and the remaining amount within 28 days. You can take out bridging loans to complete the purchase of an auction property within a given time frame.
- Landlords Looking To Expand
It is expensive to build a property portfolio and many landlords rely on rent for the purchase of new properties. However, for landlords who are not willing to wait for a long time, a bridging loan can be a perfect solution for expanding their property portfolio. The amount can be repaid by refinancing to a long term solution.
- Solving Business Short term Cashflow Problems
There may arise cash flow problems when running a business. Such problems can occur due to different reasons, for example when customers are paying their invoices late or a bank may call for an overdraft facility. You can take a bridging loan to solve short term cash flow issues and can use this amount to pay wages or to purchase new equipment.
- Repossession Prevention
If you are in a difficult financial situation where your property can be repossessed if you do not repay the debt. You can take a bridging loan to pay your debts and can sell your property on your own terms instead of a forced sale.
Other than these purposes you can use a bridging loan to pay a tax bill, Buy-to-let investment and divorce settlements.
Pros of Bridging Loans
The main advantage of bridging loans is that it helps you to secure an opportunity that otherwise you may miss. Other than that a bridging loan has the following advantages:
- The lending process is easier compared to traditional loans.
- You can take a large amount to fulfil your financial requirements.
- This type of borrowing offers a lot of flexibility to borrowers.
- You can get quick access to cash.
- Lending criteria is relaxed compared to conventional bank loans.
Drawbacks of Bridging Loans
When you take a bridging loan it may leave you in a burden of paying two mortgages and a bridge loan during a period when you are waiting for the sale of your property. Some other drawbacks include:
- Your home is used as collateral so there is a risk of losing your home.
- There are a lot of fees attached with bridging loans.
- The interest rate on bridging loans is higher than the traditional loans.
Now that you know all the information about bridging loans it will become easier for you to decide whether you should take out a bridging loan or not. You can visit our list of best-bridging loan companies to find out the best bridging loan providers in the UK.