How Does A Bridging Loan Work?
What is a Bridging Loan
Bridging loans are a specific class of short-term, interest-only finance that are designed to help borrowers, normally homeowners, ‘bridge’ the gap between paying for a property purchase and receiving the funds from longer-term borrowing. This form of lending is most commonly used as short-term funding for a property purchase when a gap exists between a payment being required (on a new property) and credit becoming available (from the sale of existing property). However, in other circumstances, bridging loans can simply work as a short-term loan to fund a renovation or development project.
Bridging Loan benefits
Bridging loans are widely used and can be a useful tool for borrowers who are looking to complete a property purchase that would otherwise not be a possibility. This flexibility does often come at additional cost depending on the interest rates obtained, but the possibilities for completion that are opened by bridging loans normally means that this cost, on consideration, is acceptable due to the potential benefits that a well-executed bridging loan can bring.
How Bridging Loans work
In principle, a bridging loan is actually a relatively simple form of short-term financing. The loan is put in place to assist a buyer in completing the purchase of a property, usually before their existing home has successfully sold. This short-term lending is normally at a higher rate of interest compared to a traditional mortgage, and a mortgage being taken out on the new property will often be the way that the bridging loan is repaid.
As property purchase chains have become longer, more complicated and convoluted, bridging loans have thrived. However, this traditional use for bridging finance is not the only way it can be used for the benefit of a property purchaser. Bridging loans are also used by buyers looking to renovate a property and sell it on quickly (rather than a full mortgage application), and also buyers at auction who need quick access to funds to aid completion within set timescales, normally 28 days.
Bridging lenders aim to look at the specific circumstances surrounding a potential loan, and as traditional banks have become more hesitant to lend this has created a more competitive market in bridging finance, which is generally seen as a positive for borrowers. The large bridging finance marketplace that now exists means costs are beginning to reduce, service levels are improving, and options for borrowers are greater.
Bridge Loans at work
Examples of potential users of bridging finance vary from case to case. In many situations, bridging finance is used by landlords and both amateur and professional real estate and property developers who want quick access to finance, either to buy, renovate and resell at a profit, or to ‘bridge’ a gap between the sale of an existing asset and the purchase of a new one. These types of buyers are also likely to be scouring auctions for potential bargains, with bridging finance offering a quick, easy way to help secure properties bought at auction.
In some more unusual cases, asset-rich borrowers may look to use bridging finance as an alternative to a traditional mortgage, although the higher interest rates and associated arrangement fees and costs can mean this might not be the right choice for every potential borrower. Bridging finance companies are reliant on their appeal as a quick lending option, but this means that the costs involved for borrowers are higher and is why they should generally be treated as a short-term option.
Traditionally, bridging loans were thought of simply as a way for borrowers to ‘bridge’ the gap that may exist between a new property purchase and the sale of an existing property. However, this description fails to explain one of the key reasons that bridging loans are now also used in a variety of other, more nuanced situations, namely speed. It is not uncommon for traditional lenders like high street banks and mortgage providers, even with the assistance of a mortgage broker, to take months to process an application and release funds, which means a huge marketplace for quick finance has been created. In many cases, a bridging loan can prove a sensible option for borrowing simply because other alternative forms of finance would take too long to secure. Of course, potential borrowers need to carefully weigh up the risks and associated costs of different forms of finance. Bridging loans do unlock the possibility of improved speed, but this can come at the compromise of higher cost.
Understanding Bridging Loans
What is important for any potential bridging loan customer is an understanding of the process and an awareness of their exit strategy. After all, in the vast majority of cases, a bridging loan is designed to be a short-term, not long-term funding solution. The application process itself is likely to be relatively simple, as this is one of the key selling points of bridging finance and other types of finance for property development. Normally, most borrowers will look to take out a bridging loan to buy a new property, sell their existing home (and repay the mortgage), and then take out a new mortgage on the new home, using the funds released from this borrowing to repay the higher rate bridging loan.
Borrowers need to carefully assess all the stages of the process to minimise risk. After all, there is no guarantee that they will be able to successfully take out a mortgage on the new property, and this may be the way that they are looking to repay the bridging loan. This inability to repay borrowing could put the home itself at risk. If used correctly, however, a bridging loan can help to successfully unlock a purchase that would have otherwise been impossible.
Bridge Loan example
To give an example of where bridging finance could be useful, consider a homeowner with a £400,000 house, where the existing mortgage is £200,000. This homeowner has found their new dream home, on the market for £600,000, but the vendor will only sell on condition of contracts being exchanged within 28 days, and completion taking place within six weeks. Of course, it would be unrealistic for the buyer to expect to sell their existing property in this timeframe, so they may choose to use a bridging loan to help. This buyer needs £600,000 (plus stamp duty and fees) to pay for the new home, but their income is not enough to secure a mortgage for this amount from a bank when taking into account their existing borrowing. Instead, a bridging loan for the full amount can be used to help buy the property before selling their existing home. Once their existing home sells and the mortgage is paid off, the remaining funds as the deposit for a mortgage on the new property. When these mortgage funds are received, they are used to pay off the bridging loan amount.
Bridging loan providers vary in their size and capabilities and what, if any, costs and administration fees they might charge, but many are now regulated by the Financial Conduct Authority (FCA). If you are a potential borrower, be sure to find both a lender and a bridging product that fit your needs, and not the needs of the lender. Bridging loans can offer a useful way to ‘unblock’ a chain or secure quick funding for properties bought at auction, but the borrower will need to weigh up the advantages against the higher cost of borrowing. In the right cases though, and in the right hands, a well-executed bridging loan can help the borrower succeed with a purchase that would have otherwise been completely impossible.
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