Giving in to a short-term loan for a quick fix to a temporary problem can be a lifeline for many. A bridging loan, originally designed to help borrowers quickly access cash when trapped in a real estate chain, could be the answer.
Bridge financing can be used in many different ways – it’s not just for home ownership. Many are used for business ventures, for paying a tax bill, and even for divorce settlements. Here’s everything you need to know about bridging loans.
What is a bridging loan?
This is usually a short-term arrangement – usually offered for a term of between one and 18 months, with the loan being repayable in full at the end of the term.
Bridge loans are secured loans, unlike a standard bank loan which is unsecured. This means that the loan is secured against your house.
Once approved, a fee will be applied to your property, which means you have entered into a legal agreement that prioritizes lenders who will be paid off first if you do not pay back your loan.
What is a bridging loan used for?
If you’re having trouble finding a buyer to buy your home, bridging financing can help you move into a new home before you sell yours.
Loans are also used to finance auction purchases if you don’t have the initial capital. Developers can use them to pay for renovations on rentals as well as to convert commercial properties.
Outside of home ownership, you might want to consider a business start-up bridging loan or pay a tax bill while you wait for bills to pay. You can even use one for a divorce settlement. The majority of divorce court proceedings center on the division of assets, which can be difficult when the assets need to be liquidated to be proportionately divided.
Bridge loans are also useful if you have blemishes in your credit report, as lenders might be less concerned about bad credit history or arrears, since monthly payments can be added to the loan balance.
How do bridging loans work?
There are several types of loan. There is an open bridging loan for which there is no end date for repayment of the borrowed amount. This works well if you’ve found a home that you want to buy but haven’t yet found a buyer for your existing home. It can also help if you are a real estate investor and need to finance a home improvement project before you sell it and pay off the bridging loan.
A closed bridging loan will have a settlement date by which you have to repay the loan in full. This is suitable if you have bought a new home and already have a buyer for your old home and just need to wait for completion to happen.
A bridging loan can be accompanied by a first or a second loan – this is the repayment priority in the event of default on the loan.
Your mortgage is the first charge, but if you take out a bridging loan to pay off your mortgage, the bridging loan becomes the first charge.
Unlike other forms of borrowing, monthly interest is often built into the loan, meaning there is no repayment to be made during the life of the loan.
How much can I borrow?
The amount you can borrow depends on the value of the property you are securing the loan against. You can borrow as little as £ 5,000 up to several million pounds for developments. Generally, the amount is limited to a maximum loan-to-value ratio of 75% of the value of your property.
If you take out a first charge loan, you will usually be able to borrow more than if you take one with a second charge attached.
How much do they cost ?
Bridge loans are more expensive than a normal residential mortgage.
You can expect to pay between 0.5% and 1.5% per month. The annual equivalent rate (APR) on a bridging loan is between 6.1% and 19.6%, which is much higher than many mortgages.
Like conventional home loans, bridging loan rates can be fixed or variable. There is also an administration fee to pay – around 2% of the loan value.
What are the disadvantages ?
Besides one of the main drawbacks of a bridging loan is its cost, because bridging loans are secured, if you default, you could lose your home – or any other asset it is secured against.
How to find the best offer?
Bridge loans are specialized financial products and are generally not offered by large banks.
You will need to speak to a specialist broker. If you do your own research and compare products from different vendors, always consider the total cost of the loan, rather than just the interest rate. Many lenders charge exit fees, management fees, and other hidden fees that are important for you to understand before signing on the dotted line.
What are the alternatives to bridging credit?
Consider all of your options before taking out a loan. If you decide that the risks and costs of a bridging loan are too high, you can explore alternatives.
You might consider remortgage to raise additional funds.
A Personal loan from a bank might be the answer, depending on how much you need to borrow. You can compare interest rates and monthly costs on a comparison site to make sure you get the best loan on the market.
You can also use a temporary extended overdraft. Talk to your bank if you think it might improve your situation.