What are Bridging Loans?

What are Bridging Loans?

One of the key elements in securing funding is Timing. You have to make sure that the funding you get comes just right on time when obligations start popping up. It’s the only way to make sure that you don’t put yourself in a situation where you are faced with debt and no source of credit is readily available for you.

But what, in the off chance, that you do find yourself in such a situation? What is your option if your stuck in the Financial equivalent of in between a rock and a hard place? This is where Bridging Loans will become your go to source of funding. And in order to make full use of such option, there are a few things about the concept that you need to know about first.

What Exactly are Bridging Loans?

The best definition of is that it is a short term, property backed, and interest-only type of loan that allow you funding for a period of time while also not preventing you from refinancing yourself to a longer-term debt or in selling a property.

In essence, it “bridges” the gap that you might encounter when you are faced with incoming debt while there are no available mainline sources of funding for that period of time. A key feature with bridging loans is that they have one of the higher interest rates among the various financial products provided in the market right now.

You might think that that makes bridging loans a hassle to deal with but the truth is that they are actually quite flexible with the obligations they impose. They are quicker to arrange and the terms on offer can be changed depending on the policy issuer.

How Does it Exactly Work?

To understand how Bridging Loans work, here is a scenario: suppose that you are planning to buy property from a public auction. You’re intention is to renovate the place, add some new additions here and there, and then sell it at a higher value.

However, you don’t exactly have the money with you right now. In fact, you don’t have any money with you right now to even validate your bid.

Normally, this would get your bid disregarded but you can apply for a Bridging Loan to get your bid honored. When you apply for a bridging loan, the lender would ask for what purpose you are applying such a loan.

Provided that you can prove to them that such purpose is necessary and that you have the means to achieve your plans, they will release the funds and you can purchase the property you won at the auction.

Why are Bridging Loans Offered?

There are a number of reasons why bridging loans became popular in recent years but they all boil down to one, major crux: getting other loans has become harder in recent years. Banks and other lending institutions right now are becoming more reluctant and pedantic to provide the usual loan products to people; most especially homeowners.

Perhaps the recent fluctuating state of the economy has made loaning institutions all the more cautious when providing loan contracts to applicants. Due to instability in the market, lenders are not too keen to be opening new contracts and expose themselves to more risks.

But problems do provide opportunities for solutions. With the need of funding still strong, there was are still a number of bridging lenders appearing in the market with an appetite to do business.

There are a number of reasons as to why bridge loans are applied for but they all boil down to the following:

Buying at an Auction

This is where the scenario a few paragraphs before falls. Winning bidders at property auctions for real property usually need to exchange contracts and, most importantly, pay the deposit as soon as the auction is over. The full amount will then have to be paid within 4 weeks or 28 working days.

Mortgage is not highly applicable in this scenario as the approval period can take longer than the grace period given to you by auctioneers. Bridging loans can be put up in a shorter time. Then, you can pay on the loan through the sale or a remortgage

Rejection of a Mortgage

There are many reasons why people get rejected out of a mortgage application. This includes a bad credit report or having no means to pay for the obligations arising from the contract. However, that problem may only be temporary as credit reports can be fixed and financial deficits can be overturned.

With a bridging loan, you can have the money necessary to purchase a property as soon as possible before anyone else makes a counter-offer. Once you have the means to provide for the obligations, you have the option to switch to a standard mortgage.

Renovations

One other reason why mortgages get denied is that the property the applicant wishes to use the money for is deemed uninhabitable.

As such, this leaves renovators with a dilemma: how are they supposed to get funding for something that the would-be lender is hesitant to provide funding for?

This is where a bridge loan would serve as a viable alternative as their terms can be made to be flexible enough to give the buyer enough money to carry out their work. Once the property is re-mortgageable, the buyer can then sell it to pay for the loan. This makes bridge loans also applicable if you want to renovate the property and borrow against its increased speculative value.

What are the Pros and Cons of a Bridging Loan?

As with any financing product, there is both an advantage and disadvantage to expect when applying for bridging loans. As such, you have to consider both the pros and cons inherent to this loan product. They are the following:

Pros

Fast Approval Process

A bridge loan can be approved in as little as 14 days. This is far shorter than usual loans which takes 3 weeks to a full month to get approved.

No Monthly Repayments

Bridge loans usually do not require regular installment payments in order to pay for the full amount. This makes it easier for you to raise capital if your finances are currently tight but have still enough to pay for the rest of the amount you loaned.

Competitive Interest Rates

Bridging loans are the hottest thing in the finance market right now. As such, they enjoy from relatively low and competitive rates with interest going as low as 0.37% per month. For completeness they could range up to 1.5% per month too.

Low Asking Price

The nature of bridging loans allows you to request for the speculative amount of the property even if its current market value is low. This means that it is highly possible for you to purchase the property without having to put in a separate deposit for the loan.

Potential for Strong Return of Investment

Bridging loans are used nowadays to fund projects that would turn uninhabitable and cheap properties into potentially high-selling prime property projects. In essence, you can use the loan for example, to buy a property cheap, add in some improvements, and later sell the entire place for more than 3 times its former selling price.

No minimum term

ie Loans could be repaid from day 2 onwards.

But for everything that is awesome about bridging loans, you also have to consider its potential setbacks which include:

Cons

More Expensive

Compared to traditional mortgages, bridging loans are comparatively pricier. Even with dropping interest rates, traditional mortgages are still the cheaper and more economical alternatives for most home buyers.

Potential Repayment Issues

As with most short-term loans, you can face problems with your chosen repayment method. If you can’t repay everything within the set period, you leave yourself at risk of having the property you bought and improved using the loan repossessed by the lender.

What Other Factors Should I Consider before Applying for One?

Before you even consider applying for a bridge loan, there are a number of things you have to ask first?

What is the Total Cost for the Loan?

It is a standard in looking for loan products that you not only look at the interest rate but also the total cost of the loan before applying. People think that low interest rates are good but that could be easily counteracted with fees like exit fees, management fees, and other so-called “hidden” charges. In essence, you may think that you are saving money on your loan but you are actually spending more.

What’s Your Repayment Method?

One of the dangers with bridging loans is that you are unable to pay for the total amount once the period expires depending on the repayment method you chose. Always put enough thought on how you will repay the loan upfront and make sure that the exit method you choose is highly viable.

If you are planning to sell the property, make sure that the terms of the loan provide an ample period of time for you to find a buyer and for the sale to be completed. That means either you have not a lot to pay for the loan or just enough for it which results in a break-even for you.

If your exit strategy involves shifting into a longer-term loan, you should check if the terms of the bridging loan and that of the loan you are applying for are compatible with each other.

What Bridging Loan Type Should You Get?

Normally, lenders would offer you two types of bridging loans.

Closed Bridge Loan

This loan requires you to determine exactly how you will be repaying the amount. This means that you will have to put in writing or explain clearly to the lender of your “exit plan”, the method you are going to use and repay for your obligations. Typically, closed bridge loans must be settled within a few months.

Open Bridge Loan

Unlike the closed plan, this loan does not require you to detail your exit plan out of your obligations. This means that they are the more time-saving alternative as you can get the funds for urgent or emergency transactions. Also, they have a longer time table for repayment going up to a year or 18 months, depending on the lender.

Is this a First Charge or a Second Charge?

Second charge loans are applied if you already have secured a loan against a property with an outstanding mortgage. In other words, you might get another bridging loan to pay for improvements since you already secured a first loan to buy the property which is the first charge.

Knowing if the loan you are applying is either the first or second charge will let the lender know your priorities if obligations from such a loan arises. Due to the nature of second charges, there is a chance that you may not have the means to pay off for the loan as you are focusing on clearing down the first loan.

What is the Rate?

The rates of a bridging loan can affect your ability to pay for the entire amount. A fixed rate, for starters, is ideal for those that want a bit of stability in their exit plan. This is for the simple reason that you have agreed to the entire amount beforehand.

The only disadvantage with fixed rates is that they are generally higher. You may end up paying for more as you pay for the security.

Alternatively, variable is great for those that are used to a bit of flexibility with their payment methods. The primary amount may change from time to time but you may end up saving more on the long run.

But, then again, its variability can work for and against you. If market rates are on the verge of spiking upwards, it might be better for you to pick a fixed rate.

Aside from fixed and variable rates, you should also consider other payment rates for a loan.

Monthly Basis

The interest is separate and the total sum is not added to the entire loan balance.

Rolled Up

Here, you will pay for the entire compound interest along with the loan’s amount when payment is due.

Retained Interest

In this payment method, your monthly interest is covered until a date agreed upon by both you and the lender. This is so that you can pay the full amount when it is due.

Are there Any Other Fees Involved?

Aside from the total amount loaned and the interest, you should also be mindful of any charge that the lender can add to the loan on top of everything else. These include:

Arrangement Fees – This is the fee the lender asks for having to set up the contract with you. Under the law, the amount for this charge goes in between 1 to 2% of the total loan.

Exit Fees – If you plan to pay your dues before the agreed time expires, some lenders might charge you for a fee of around 1% of the entire loan just for doing such. Fortunately, this is not a common practice among lending institutions but you have to ask of such from your lender first.

Repayment Fees – These charges are often meant to compensate the lender for the costs they entailed processing the contract. This, of course, includes the paper work and other pertinent matters to your transaction with the lender.

Valuation Fees – This is to cover the fees of the surveyor who is going to assess the property for its new value over the old one based on your investment on the place.

To Sum Things Up

The point of all these questions is that you must make sure that you understand everything about the loan before applying for one. This includes terms as well as the obligations that could arise from binding yourself to such a contract.

If possible, always ask for a complete breakdown of costs before taking a loan. Lenders are compelled by law to provide every pertinent information that you ought to know before you fill in the application. After all, concealment of material information would leave these firms in serious trouble with the law if such a fact were to be discovered.

How Much Can You Borrow From a Bridge Loan?

Due to where bridge loans are usually applied for, the amount that you can borrow from such products are more than considerable. The sweetspot as it were ranges from £100,000 to £1,000,000. This is the main bridging market. Between £25,000 to £100,000 means there are fewer lenders available to look at these loans. Below £25,000 is not very open at all.

But, if you plan to purchase properties, especially large ones, you can expect to have the loan go up in between £1,000,000 around London depending on the valuation of the property. The farther away from London the more difficult it becomes. At the top end loans of £5,000,000 are also rare. With some lenders, you might even borrow more if you can put a number of properties forward or have a compelling enough plan to buy one property and turn into a massively profitable venture.

But here is one thing that you should know about the lenders. Even if they approve your loan, they will rarely pay the full amount. They will provide you with a quote based on the loan to value rate of the property which can go in between 65% and 75% of the total value if the property is residential in classification. For commercial properties, that LTV is going to be in between 60% and 65%.

The reason for this is that commercial properties are actually harder to value and even more difficult to sell later on given the current state of the economy. For residential properties, the valuation is easier as there are more sales to compare with and come up with an accurate value.

Either way, higher LTVs often denote higher risks for the lender. As such, it makes perfect sense why lenders would hold out on giving the full amount to any applicant, no matter how good the deal is.

What are the Requirements for a Bridging Loan?

As with other financial products, the requirements for bridging loans would vary from one lending institution to another. However, you can expect for the application process to be the same across all of your potential lenders. This includes you filing an application, the lender processing your application, and waiting for the mandatory period before the loan is approved and you can collect on the amount.

But when it comes to bridging loans, you can expect that the lender will be primarily focused on the value of the property which shall be used as collateral for the loan. Of course, your financial information will matter and this includes your credit report, your statement of income and assets, and other financial records.

For some more complex bridge loans that deal with investment properties, other documents will be required such as lease agreements and other similar contracts.

To Conclude

Without a doubt, bridge loans are a great option for those that are buying and investing on real estate properties. But, as with any loan, the best way to enjoy the benefits of this financial product is to keep up with the terms and conditions you have signed up for it.

Hopefully, this article was able to inform you on what a bridging loan is and what you can do with it. All that is left to do now is to find out what short-term financing options are made available for you in your area.