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What is a bridging loan?
Bridging loans are a form of short-term finance, usually taken out for about a year — before longer-term financing can be secured. Bridging loans typically require security — in most cases property as collateral.
Bridging loans — considerations
Bridging loans are great solution for businesses, real estate developers and investors looking to quickly get funding — for a property purchase.
A bridging loan can be seen as interim finance — until more permanent, longer-term finance is obtained. Money from the longer-term financing, is then used to pay back the bridge loan, and also used to further, or complete the project being undertaken.
Bridging finance may be used in a number of ways. For example, bridging loans can be used as a stop-gap, before a mortgage can be secured — after you purchase a property at auction. Alternatively, you may use a bridging loan to quickly refurbish/develop a property — before going on to sell it. Bridge finance can also be used to raise capital or meet tax obligations — by the way of refinancing property you already own.
Bridging loans are usually approved for between 1-24 months, with the loan to be paid in full at the end of the term. In contrast to conventional loans, the monthly interest is usually rolled into the loan — which means that you make no repayments during the loan term. Having said this, you can find bridging loans that require you to pay monthly interest.
To compensate for risk, bridging loans are usually more expensive (higher interest rates) than other forms of traditional lending. But, the funds can be processed and arranged relatively quickly.
Due to the higher interest rate payments, it is important that you have an exit strategy — before committing to any bridging deal. For those interested in bridging loans for commercial real estate, suitable exit strategies include: finding longer-term financing, such as a commercial mortgage, or simply selling off the property in question.
As bridging loans are a form of secured loan, having poor credit ratings and little trading history — are not really an issue.
The loans can either be “closed” or “open”. With a closed bridge — the borrower has a set repayment date, while with an open bridge — the borrower proposes an exit plan to repay, but there is no definitive deadline.
How do bridging loans work?
Businesses looking for a bridging loan would approach a specialist lender. You would provide the lender with detailed information including: reasons for wanting the bridge loan, the security to be provided and your repayment strategy.
Based on the information provided, the lender may make you a preliminary offer — subject to certain conditions being met. Those conditions would usually involve things like seeing evidence of the property purchased and/or getting valuation reports done for assets offered as collateral.
The size of bridging loan approved, is based almost entirely on the value of the asset you offer as collateral.
The lenders offer will outline how and by when you are to repay the monies lent to you. You may negotiate to make Interest payments in monthly installments, or in whole when the entire loan is repaid or have the interest retained from the loan at the outset.
Depending on the lender, other fees you could be asked to pay include: valuation fees, facility fees, legal fees, administration fees and exit fees.
As a condition of taking out the bridging loan — a “charge” will be placed on the property you offer as collateral. This is a legal agreement which outlines which lenders will be repaid first — should you default on your loan.
If you own the property outright, the bridge loan would be “first charge”. However, if you still had a mortgage on it — it would be a second charge loan (behind the primary lender).
Benefits of a bridging loan
- Fast applications — funds can be released quickly
- Flexible lending criteria
- Option for no monthly interest payments — easier to manage your cash flow
- Good solution when high loan-to-value (LTV) mortgages are unavailable
Limitations of a bridging loan
- Higher interest rates — than conventional loans and mortgages
- There may be extra legal and administration fees to be paid
- Loans are only approved for the short-term
- Requires collateral
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