How Do Bridging Loans Work?
Monday, March 9
So you have heard about bridging finance, that it is a viable way of raising finance in a hurry. But you are the prudent type that won’t rush into anything without considering all the pros and possible cons. You are asking, how do bridging loans work?
To answer that question, here is a common scenario:
You have raised a family but all your children have grown and the big family house that used to be a hive of activity is now very quiet and feel its big size. Besides that, the big house costs a fortune to maintain, with its large garden, out-sized deck, and outbuildings.
It makes sense to sell the big family house and buy a small retirement cottage in that small town you have always wanted to retire to. But unless you can sell your house fast enough, that retirement cottage you have set your sights on will be snapped up before you can put in an offer. And to make matters worse, your large house may take months to sell. So what do you do?
You apply for a bridging loan. A bridging loan is simply a short term loan you take out to cover an emergency need for finance while you arrange longer term financing. For our retiring couple, the bridging loan would ‘bridge the gap’ between purchasing their dream retirement cottage and getting paid for the family house they are downsizing from.
When Do You Take Out A Bridging Loan?
You take out a bridging loan when you have a time-critical need for cash but cannot wait the time it takes to have your longer term loan approved by the bank. For mortgage bridging loans, the property you have put on the market and from whose proceeds you intend to buy your new house secures the bridging loan.
In fact, you can take a bridging loan for a variety of purposes and, for that reason, there are now several types of these loans you can apply for. Here are a few types of bridging loans that your short term loan provider may approve for you:
● Refurbishment bridging loans
● Land bridging loans
● Cash bridging loans
● Auction bridging loans
Whenever you have an emergency need for cash for a specific purpose and can provide acceptable collateral, there is a good chance a bridging finance institution can structure a suitable bridging loan and release funding. Most bridging loans are secured by immovable property, like your suburban house, flat, or commercial properties like shops, parking lots, industrial complexes, and rental apartments.
Bridging loans can be a source of home refurbishment finance where you prefer not to remortgage your house to fund the home improvement project. There are also times when you need credit to take advantage of a time-sensitive investment opportunity that would be lost if you waited for the time it takes to get a loan from a bank. If you own a residential property you can release value from it by applying for a bridging loan and then using it to secure the loan.
How much can you borrow with a bridging loan?
The amount of credit you can obtain through a bridging loan depends on the value of the collateral security you provide. In other words, your lender wants to be sure they can recover their money in the event you default on the loan repayment.
In most cases, the amount your bridging finance lender approves for you is calculated as a percentage of the total value of the security you provide, usually 70 percent. So you will be asked to provide the balance as a deposit. But you can be approved for more than that if you can provide extra security.
Bridging loans commonly have to be paid within 12 months, but you can stretch the loan term to 18 months depending on the lender you are using. So a prominent feature of bridging loans and the main reason you have to carefully consider this option before applying is they have to be paid off in a very short space of time compared to loans bank typically offer.
It is, thus, important to carefully weigh the effect the bridging loan will have on your finances in general. If it is a refurbishment loan, consider your household budget and how adding the loan repayment will affect your finances. Your lender is also interested to know how other financial commitments you already have will affect your loan repayment.
How much interest do you pay on a bridging loan?
There are no hard and fast rules on the interest your lender will charge on your bridging loan. The rate is arrived at after considering your whole application. But interest rates for bridging loans are typically higher than those charged by traditional financial institutions.
When you look at it, interest rates are a way for lenders to make money as well as a hedge against the potential risk you may default or fail to repay the loan altogether. So, the strength of your credit score and the value of the collateral you provide has a big bearing on what interest rate your lender will offer you.
How do you pay back a bridging loan?
By their nature, bridging loans have to be paid off before a specified time lapses. But another feature of bridging loans is their flexibility. This flexibility means you can pay off the loan early, which also allows you to save on interest charges.
When you look at it, bridging loans have to be flexible. They are a means of raising finance while you wait for a property to sell or while your bank approves a longer term loan, which means there is every chance you can secure the long term funding you desire before the bridging loan term has lapsed. In this situation, you should have no reason to delay paying off the bridging loan.
The flexibility of bridging loans, however, does not mean you can delay repaying the loan beyond its term. If you do that, your lender will seize whatever you provided as security for the loan. Importantly, you will want to respect the bridging loan’s terms to keep your credit history clean and to protect your chances of securing bridging finance in future.
Are Bridging Loans A Good Idea?
Bridging loans are like any other loans. They provide a funding solution where you cannot raise it from your own resources. The question on whether they are a good idea or not depends on how productively you use the money. In most cases, they are a viable way of raising money at short notice.
Another benefit of bridging loans is they are not subject to the stringent lending conditions you will expect from traditional lenders. Even people with poor credit scores and those that cannot provide a verifiable source of income can get approved for bridging finance. These loans are also a convenient way to raise credit for small businesses struggling to for capital.
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