Are Bridge Loans a Good Idea and should you get one?
These short-term loans help borrowers meet their current obligations until they can secure alternative finance.
So, when it comes to property, a bridging loan provides finance when moving from one house to another: this is during the transition period between buying a new house and selling your old home.
This article will explore bridging loans in further detail and assess whether they’re a good idea in the first place.
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How do bridging loans work?
A bridging loan is usually used to pay off a person’s old mortgage so that homeowners can transition to their new home and related mortgage. Sometimes a bridging loan may pile new debt upon old debt, when taken as a second charge loan (when you secure an additional loan behind your first loan).
Property investors, for instance, sometimes use a bridge loan when they make a property purchase at auction: they need immediate funding because you must complete these transactions within 28 days.
People may also get a bridging loan for other time-sensitive property transactions; some homeowners might even get one for property renovation.
Because bridging loans are secured loans, you’ll need to have an asset as security for your loan. This means that if you fail to repay your loan, the lender can oblige you to sell whatever asset you’ve tied to your loan.
You also shouldn’t have too many issues getting your bridging loan accepted, as the lender has a fallback should you fail to make your payment. This also means that bridging loans are suitable for people with bad credit.
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Types of bridging loans
Lenders offer bridging loans that are either open or closed. Open bridging loans are more expensive but more flexible than closed bridging loans because there’s no set repayment date.
Closed bridging loans are usually only taken out for a couple of weeks or months, and because they’re “closed,” meaning that they’ve got a clear end date based on repayments, you’ll typically need a good exit plan (more on these later).
Obtaining closed bridging loans requires proof of how you intend to pay the loan, and you’ll need to commit to a fixed date for repayment.
With open bridging loans, you’ll typically be expected to pay the loan back within six to twelve months. Failure to pay back your bridge loan will result in penalty fees. You may also be able to make interest payments, paying all or some of the interest back before paying the total amount.
Pros and cons of bridging loans
Now that we understand what a bridging loan is and how it works, let’s get into the downsides and benefits to assess whether it’s a good idea for you:
Benefits
There are many key benefits of a bridging loan, including the following:
- A bridging loan is flexible and can be used for various reasons for different property types.
- They’re reliable, as bridging lenders can help you secure your existing property (quickly). This is one of the main upsides and the primary reason people get these loans.
- Along with being able to borrow soon, you can do so with large amounts of money.
- These loans generally have flexible repayment terms that fit into your plans.
Downsides
Unfortunately, there are several downsides, including:
- A bridging loan has a higher interest rate because of their flexibility and how quickly they’re granted.
- A bridging loan has many additional fees on top of the high interest rates. You’ll have to pay an administration and arrangement fee and legal, broker and valuation fees. The valuation fee alone can be anywhere between £900 and £2000.
- Your bridging loan requires security in the form of an asset, which might often be your home. Failure to make timely payments could cause your home to be repossessed.
Can you trust bridging loans?
A bridging loan can be trusted because the Financial Conduct Authority usually regulates it. However, you can get unregulated bridging loans, although these will not be available for loans on a borrower’s home.
Because it’s a business transaction, a bridging loan taken out in a company’s name will be unregulated.
Eligibility criteria
You’ll need to meet specific eligibility criteria to get a bridging loan. For example, a bridge loan requires clean credit, and the majority of UK lenders will require this, although it is possible find someone who’ll lend to you even with bad credit.
But what about the bridging loan cost? Bridging loans require a high deposit so that you can get an excellent loan-to-value rate. You’ll already need to deposit about 25-35% of the property value; however, depositing 40% will give you access to better rates.
And, if your exit strategy for bridge loans is selling a property, having a security property that will undoubtedly exchange for the desired amount is essential. Bridging lenders will also assess this property for variables that may deter buyers.
The exit strategy
A bridging loan is only a good idea if you devise a decent exit strategy (how you’ll pay the loan off). Strategies for doing so generally include:
- Selling a property you own or even the property you bought with the loan.
- Selling assets.
- Using cash from divorce settlements or inheritance.
Alternatives to bridging loans
Are bridge loans a good idea? Before giving a definitive answer to that question, it’s essential to contemplate any alternatives to borrow money other than bridging finance:
Mortgage loans
Mortgage loans, such as taking out a second charge mortgage, should only be considered if you have long-term loan needs. You should differentiate bridging finance from mortgage loans in that it is only for short-term use.
You may also opt for a mortgage if you’d like to avoid high interest rates since, as long as your credit is good and you fulfill their criteria, lenders will offer you much lower interest rates on mortgages.
Guarantor mortgages
You may opt for a guarantor mortgage instead of a bridging loan if you struggle to get a mortgage because lenders find you unsuitable for a second mortgage (or because of bad credit). Instead of being secured onto an asset you own, guarantor mortgages are secured against your guarantor.
Commercial mortgages
Commercial mortgages are available for up to 25 years, unlike bridging loans, which might only be for a few months. However, these loans are given solely to businesses to purchase commercial properties.
In addition, unlike bridging loans, commercial mortgages are not flexible. This bridging finance will also likely come with early repayment charges if repaid early.
Negotiate with your current lender
If you’re taking a bridging loan to cover your existing debt, then a good alternative would be to negotiate with your lender about changing your repayment terms so that the bridging loan is unnecessary.
Alternatively, you may take out a bridging loan if you sell your property soon.
FAQs
Do people still use bridging loans?
People still use bridging loans, with investors mainly using them to bridge gaps in their current deals or fund new ones.
Are bridging loans high-risk?
Because bridging loans are high-interest short-term loans, it follows that they would be considered high risk. The average interest rate of a bridging loan is about 10-12% each year.
How safe are bridging loans?
A bridging loan from a registered lender is entirely safe; however, there is some risk with bridging finance taken out from unregulated lenders because they’re not accountable.
How long does it take to approve a bridging loan?
The amount of time it takes for a bridging loan to be approved varies depending on the lender. Some bridging loans will be approved within three days, while others might take a few weeks.
Interested In a Bridging Loan?
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