People and businesses often face the dilemma of lacking funds while trying to meet specific obligations. In times like this, individuals and businesses turn to bridge loans as an immediate solution.
Bridging loans fund a property’s purchase while waiting for a more permanent source of funding, such as income, sale of another property, or a new mortgage. This type of line is a short-term financing option that generally lasts for three months up to one year, and it requires real estate property or business inventory for security.
This alternative finance option is increasingly growing in popularity in the UK, but it is not without setbacks. Learning what it is and its associated costs can help you determine if such a quick fix is suitable for you and your business.
What Are Bridging Loans For?
Also known as interim financing, swing loans, or gap financing, bridge loans serve as a transition from one financial product to another. In the UK, it is typically used by individuals who want to purchase a new home while waiting to sell an old property.
On a business level, for instance, property managers who want to have funds for refurbishment turn to bridging loans as a quick cash source. Other businesses avail bridging loans to cover expenditures or to secure suitable business-related investments.
Key Features Of Bridging Loans
Bridging loans have three distinct features: short-term, asset-backed, and require an exit plan. Furthermore, bridging loan typically lasts from three months to one year, while some last up to two years.
Interim financing is also asset-backed and requires collateral in the form of real estate property or business inventory. In addition, lenders also require a definite exit plan to ensure that borrowers will pay the loan within the prescribed duration.
What Are The Types of Bridging Loans?
Bridging loans have four types: closed, open, first charge, and second charge.
- A closed bridging loan is available for a particular duration agreed by both the lender and the borrower. It provides a specific repayment date and it’s applicable for real estate transactions awaiting completion.
- In contrast, an open bridging loan doesn’t have a definite repayment date and method. It’s often used by borrowers who are uncertain as to when they can obtain long-term financing.
- The difference between the first charge and the second charge bridging loan is how lenders will take hold of the property that’s used as collateral. In case of default, priority is given to the first charge followed by the second charge.
Bridging Loan Calculator
A bridging loan calculator can provide an estimate of how much you can obtain from a lender. This typically involves property value, outstanding mortgage, and the amount of loan required.
The amount and terms chosen will add to the interest rate along with associated charges. Bridging loan fees include lender arrangement fees, redemption, solicitor, broker, and exit fees.
Advantages of Bridging Loans
Gap financing is popular in the UK and elsewhere because of its convenience. Applications are processed and approved in as little as two weeks, and funds are released within 48 hours. The underwriting process relies on a different set of criteria that focus on collateral and realistic exit plans rather than standard credit scores and income.
Aside from this, bridging loans are also a short-term fix suitable for obtaining quick sales and investment opportunities.
Types of Property Used As Security
Bridging loans consider a wide range of properties, either in good or poor condition. Depending on the type of bridging loan, it can include residential property (houses, flats) or building plots where the borrower currently resides or plans to reside in the future.
Aside from residential properties, like buy-to-lets, lenders also accept semi-commercial and commercial properties, development, and agricultural land along with land without planning permission.
Terms of Bridging Loans
In this type of short-term loan, the equity of the current home is used as collateral. The lender then assumes the existing home mortgage and provides for the down payment of the new property. The total amount borrowed is known as the Peak Debt, which includes balancing the two properties combined with stamp duty, lender, and legal fees.
Once the former property is sold, the proceeds are used to reduce the peak debt. The remaining balance is then repaid as a standard mortgage.
In a business bridging loan, inventory is used as security and is repaid when a long-term financing option is received.
Associated Costs
The monthly costs range from 0.5% to 1.5% and an annual percentage rate (APR) between 6.1% to 19.6%.
Disadvantages
The short duration of bridging loans becomes a disadvantage, especially when a house isn’t sold within a year. This makes the mortgages of two homes burdensome and may even lead to default. The high-interest fees and numerous charges also serve as setbacks to this type of loan.
Conclusion
Bridging loans are amenable quick-fix solutions for property purchases and business investments. As an asset-backed loan, it requires collateral in the form of real estate property or business inventory.
While taking on two mortgages can be burdensome, a key to a successful bridging loan is a clear and realistic exit plan to ensure prompt repayment and good standing.
