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What is a Bridging Loan?
A bridging loan is a short-term finance option used to facilitate a purchase while waiting for money owed to you from another source. As the name suggests, it is used to ‘bridge a gap’ through quick financing for a short period when it is not available.
A bridging loan is a secured loan, i.e. it is given to the borrower in exchange for a high-value asset as a security. Bridging loans are sought-after financing sources in the real estate industry. Bridging loans are also called by names such as interim financing, gap finance, or swing loans.
For example, you wish to acquire a property worth £300,000 before you want to sell your current property worth £250,000 with a mortgage of £50,000. Hence, there is a gap in your financing that needs to be filled.
A Bridging Loan can be a financial route you choose to buy the property and take your time with selling your existing property.
Why Choose a Bridging Loan?
A bridging loan can be an outlet through which one can pay for an asset or property before having a clear source of income. Bridging loans can be seen as a viable option under the following requisites:-
- You want a quick source of finance.
- You have a proper repayment plan.
- You want to take on a limited-time opportunity.
- You want to close on a property before selling your current property.
- You want a short-term secured loan.
Types of Bridging Loans
Bridging loans can be classified into two categories: Open and Closed bridging loans.
OPEN BRIDGING LOAN
It is the type of bridging loan issued with no fixed repayment date and usually has a repayment period of a year or can be extended depending on the provider.
CLOSED BRIDGING LOAN
It is a bridging loan with a fixed repayment period. This date is usually chosen to keep in mind when the borrower can gather funds for repayment.
First Charge and Second Charge Loans
The lender marks a charge to indicate the priority of the bridge loan in case of default. Repayment of a bridge loan in case of a default is determined by whether it is a first or second charge loan.
First Charge Loan
If the bridge loan on your asset is the first or only borrowing, the borrower would first pay off the bridge loan and then pay other debt. Hence, a first charge bridge loan gets the number one priority in defaults.
Second Charge Loan
This means that there are other debts such as mortgages or other loans on the asset that become the first charge loans. If your bridge loan is a second charge loan, that will imply that you would have first to pay the debt or mortgage and then the bridge loan in case of a default.
Generally, second charge loans need to be permitted by the first charge loan lender. There is no limit or rule on how many charges can be added to an asset or property if approved by the previous lenders.
Interest Rates of a Bridging Loan
The borrower and provider agree to choose a bridging loan’s interest rate between a fixed or a variable interest rate. A fixed interest rate is a loan structure where the loan’s interest rate is set across the repayment period. Unlike fixed interest rates, variable interest rates keep going up and down at a variable rate, usually with the Bank of England base rate.
Bridging loans tend to have a higher rate of interest than other financing sources. Bridging loan interest rates can range from 0.4% to up to 2% depending on the amount of the loan, creditworthiness of the borrower, and loan period.
Types of Interest Rates
There are three types of interest rate arrangements popularly used in bridging loans. They are Monthly, Rolled-up, and Retained interest.
This interest rate arrangement means that the claim is charged every month. The borrower will pay an amount of money every month to the lender until the principal has been repaid.
This interest arrangement system accumulates the interest amount, and the borrower must pay it in a lump sum. The borrower must pay it during repayment of the loan. This arrangement allows the borrower to choose not to pay interest every month.
This is a unique interest arrangement. The interest amount is summed up and added to the loan agreement itself. The borrower must pay back the interest amount at the time of repayment. The difference between retained and rolled-up interest. In retained interest, the borrower has to pay interest on interest. In rolled up, the borrower only pays interest on the loan amount.
How Much Can You Borrow?
A typical bridging loan allows you to borrow any amount ranging from £5000 up to £25 million and beyond. The range of borrowing depends on the loan amount, borrower’s creditworthiness, the asset used as security against the loan, and the asset’s value against which the loan is taken.
Expenses of a Bridge Loan
A bridge loan is an expensive debt route. It is usually heavily charged by other fees. These charges are:
The broker charges an arrangement fee of about 1% to 2% of the loan amount. One should avoid paying it upfront and only let the broker charge this when the loan is cleared.
A fee charged by a surveyor or a lender for estimating the asset’s value is kept as a security against the loan.
An exit fee is sometimes charged by the lender to redeem the secured asset, usually about a percentage of the loan amount.
In most cases, the borrower has to bear the charges for both parties’ legal paperwork and due diligence.
It would help if you also kept in mind other charges like bank transfer fees and broker’s charges that might be levied.
If you are looking for a short-term loan with quick withdrawal, one of the options might be a bridging loan. But keep in mind that it has a high-interest rate, and you should have a proper exit or repayment methods or repayment strategy.