What is a bridging loan? Effectively, it is a short-term finance option that can be used to ‘bridge’ the gap between two transactions. The duration of a bridging loan is generally between 6 and 18 months, but can last longer. Bridging loans are primarily secured against property, but some lenders offer the facility to borrow against other assets.
Bridging loans are ideal if you are waiting for funds to complete a property purchase or need to act quickly before another transaction completes.
For example, if you have found your dream home before selling your existing property, you could use a bridging loan to buy the new property. You would then pay off the loan once your current home had been sold.
Similarly, if you are buying at auction or have exchange and completion dates that do not match up, you can use a bridging loan to cover the period between paying for your property and receiving the money from your sale.
Structure of a bridging loan.
Bridging loans are handled differently by each lender:
Your initial loan may be repaid until you settle in your new house. However, during the bridging period, the interest is added to the outstanding balance. When you sell your existing home and pay off the original mortgage, you begin paying back the bridging loan’s principal (plus the added interest).
Other loan structures may force you to pay both loans simultaneously.
When you sell your present house, the original mortgage is cancelled, and the bridging loan is generally turned into your new home loan.
Due to the power of compounding interest, the longer it takes to sell the old property, the more interest accrues, and the more you have to pay for the loans. Interest is calculated daily and charged monthly, so it can quickly build up depending on the amount borrowed.
Consider carefully the length of the bridging period, which is usually six months for existing homes and twelve months for new homes. Lenders often impose a higher interest rate if you don’t sell your house within a specific time frame. According to one lender, if you don’t sell your home, the lender “may get engaged to sell the property” to pay off the loan.
Advantages of bridging loans
Bridging loans have advantages which include:
Easier approval process
Most banks have strict criteria for approving loans and will look into your credit score and income level before approving any loan application. But bridging loan providers do not impose as many requirements on borrowers and are often prepared to approve applications that traditional lenders would otherwise reject.
Flexibility
The flexibility offered by bridging loans is one of their most significant advantages. You can use them for multiple purposes, including purchasing property, relocating, debt consolidation, home repairs, renovations, and more.
Cost-effective
The fees charged on bridging loans are usually lower than those charged on conventional mortgages because these loans are only meant as short-term solutions until you have managed to sell your old house and buy a new one.
Takes care of the expense of a new property
If you’re purchasing a property before offering your present home, a bridging loan will take care of the expense of the new property until you offer your current home.
This will keep away from any additional expenses related to leasing or utilising an alternate credit item.
Disadvantages of bridging loans.
The following are disadvantages of bridging loans:
High-interest rates
Bridging loans are more expensive than standard mortgages. While the average two-year fixed mortgage rate is around 2.5% at the moment, bridging loan rates tend to be more like 0.75% a month, which works out at 9% annually. This means you’ll pay an enormous amount in interest over a year, so it’s best to pay off your loan as quickly as possible.
You’ll have to pay back your bridging loan within 12 months, but you should do so if you can repay it earlier. Otherwise, you risk paying substantial early repayment charges on top of your already high-interest rate.
Short-term loan
Bridging loans are short-term loans, typically between 2 months and two years. This means they’re only suitable if you know you’ll be able to pay off the loan very quickly – if not, you could find yourself in trouble as the interest adds up. If you need to borrow over a more extended period, check out our guide on the different types of mortgages available.
You’ll need to secure the loan against your home.
Your property is typically used as collateral when taking out a bridging loan. If you fail to make repayments, your home may be at risk of repossession.
It’s not for everyone.
You shouldn’t take out a bridging loan unless it’s right for you, as with any loan. They’re often used when there’s a gap in funding – but that doesn’t mean they’re suitable in every situation.
Choices of bridging loans
There are two types of bridging finance:
Open bridging loans
If you don’t know precisely how long it will take to pay off the loan, you may wish to opt for an open bridging loan. These loans offer a more flexible repayment option, but the interest rates are usually higher, and the lender is likely to ask for greater security.
Once you’ve sold your property and repaid the loan, you can close the deal.
Closed bridging loans
If you have a specific deadline set out in the contract, such as the completion date of your new house purchase, you may wish to apply for a closed bridging loan instead. The lender will only release the funds when you need them and will be repaid on a fixed date – this could be as short as four weeks or as long as 12 months.
These loans are often cheaper than open ones, but if you cannot pay it off in time and cannot extend the term of the agreement, you may be hit with some hefty charges.
Before applying for a bridging loan, you need to know the exact type that fits your situation. We can help you with all your bridging finance needs today. Contact us for a free, no obligation chat.
