A bridging loan is a temporary short term financing option normally with a maturity of less than 18 months secured against a property. Bridging finance provides fast access to cash ordinarily used by a borrower purchasing a property to bridge the finance gap between the sale date of the current property and the completion date of the new property. However, bridging loans are ordinarily a financing means of last resort given that they come with much higher interest rates than traditional mortgages and are typically offered by advisers, specialist bridging finance companies and mortgage brokers and are not normally offered by high street banks. Failure to repay a bridge loan will likely lead to repossession and very significant adverse costs consequences.
Bridging loans are typically used by landlords, property developers and individuals as additional finance to buy a new property whilst the sale of another property has yet to be completed. However, there has been a trend for lenders to offer bridging finance for alternate purposes including by borrowers:
• purchasing a property quickly for example at an auction;
• renovating or converting a property (which now represents the largest market share of bridging finance);
• covering unexpected business expenses;
• preventing a repossession;
• plugging the finance gap during mortgage delays;
• getting capital investment for a new business start-up;
• needing short term capital investment for business use; or
• purchasing stock or machinery for a business.
Whilst personal bridging loans are regulated by the FCA, commercial loans secured against properties for investment are not. Therefore, commercial bridging is unregulated. Unscrupulous lenders may make incorporation of a company a condition precedent of a bridging loan, which on its’ face would means that the loan is unregulated and can lead to hidden charges. Given the short term focus of bridging finance, bridging loans will also be more expensive and have higher interest rates than a traditional mortgage, typically alongside additional legal and administration costs.
Why use a Specialist Bridging Loan Solicitor?
Bridging finance is a niche and complex subject matter which most generalist lawyers simply will not be familiar with or understand to a level adequate enough to be able to recognize and formulate a mis-selling claim. Bridging loans (also called bridge loans) are useful if:
• You’re buying a new house but the buyer for your old house has pulled out
• You need to buy a new house quick e.g. if it’s a rare property find
• You’ve bought a house at auction and need to pay for it immediately.
Bridging loans work much like other kinds of loans, but the process is a little different:
• You borrow the amount you need to buy your new property.
• The lender usually asks for information on the property you want e.g. the sale price.
• They’ll want proof that you’ll be able to repay them. This will be either through selling your old house or with a mortgage.
• The loan is secured against your new property. If you can’t repay it, the lender could repossess the house.
There are two kinds of bridging loans – open and closed.
You have to pay off a closed bridging loan within a specific timeframe.
Open bridging loans have no definite timeframe to be repaid. It’s usually within a year. The ‘charge’ tells lenders which debts are paid first when you sell your old house. If you have a mortgage to repay, that’ll take priority. This would make the bridging loan a second-charge loan, because it gets paid off second. First-charge bridging loans are when you’ve no bigger debts to pay off. The money from selling your old house goes straight to paying off the bridging loan. The typical smallest amount you can borrow is £25,000. But there’s no fixed upper limit. These are set by the lenders and are often a percentage of the new house’s sale price. Bridging loans are short term. This means that interest is usually higher than what you’d get with a personal loan or mortgage. Lenders charge interest on bridging loans monthly rather than annually. This bumps up the interest rate even more. If you don’t sell your old house in time, you might not have the money you need to make your repayments in time. Since the lender has secured the loan against the property, there’s a risk of losing your home as fast as you got it.
There are a couple of ways to get the money you need that could be less risky than a bridging loan:
• Get a mortgage on the second property – this means you have a longer loan term, but it might work out to be not as expensive. You could use the money from the sale to make mild over payments to the mortgage. Be sure to not overpay too much or there may be a charge.
• Take out an unsecured personal loan. You can borrow up to $50,000, so this may be useful if you need to bridge a smaller amount.
Since bridging loans are not intended to be used as long term methods of finance, it is very important to have a reliable exit strategy in place in order to be able to repay any bridging loan at, or before, the end of its term. This is because bridging loans usually have a high monthly rate of interest making them expensive if used for anything other than short term finance. In addition, many bridging lenders will charge additional fees, such as renewal fees, if you go over the agreed bridging loan term. Your exit strategy should therefore be a ‘sure thing’ and if it is not you need to make sure that you also have a backup exit strategy ready.
Sale of property
A common exit strategy is to clear the bridging loan following the sale of a property, in which case do your homework with regards to pricing and what price you can realistically expect for the property. It would also be worthwhile investigating what price maybe achieved if the property had to be sold quickly.
Another option used as an exit strategy is refinancing, which would typically be used if the bridging loan was taken out to help finance restoration, renovation, other building work and new developments. Once the property is finished, and in a condition that it can be used as security for a more traditional mortgage, then a buy to let mortgage, commercial mortgage or other long-term facility can be used to repay the bridging finance. If you intend to clear your bridging loan by refinancing, it is very important to ensure that you are able to obtain the required finance facility. Remember that since the credit crunch lending criteria is less forgiving as lenders have more regulation/guidelines and limited funds, so are therefore more selective.
For businesses that use commercial bridging loans to fund large orders or to cover short term cash flow problems, their exit strategy could be to clear their loan when they receive payment from customers who owe them money. In these circumstances it is probably a good idea to have a backup plan in place in the event that their customers are unable to pay their invoices.
Sometimes bridging loans are just taken out to enable the purchase of an absolute bargain which will then be sold for a quick profit. In these circumstances make sure that you are certain that the bargain item is exactly that, and if it doesn’t sell for a profit ensure that you have alternative funds that you can use to repay the bridging loan.
Risks Involved With Bridging Finance
• Payment Arrears: As with any loan, become unable to keep up to date with repayments is perhaps the most serious risk. This is especially the case with bridging as the interest rates are relatively high, as befits the short-term nature of the finance.
• Defaulting: Since all bridging finance is secured, defaulting on the loan is going to put your asset at risk. Creditors have a variety of legal options are their disposal to compel you to pay which include county court judgements, statutory demand letters and ultimately a winding up petition which could force your company into liquidation.
• Exit Strategy Failure: Since bridging finance is a loan intended to cover the space between two clear points, the exit strategy is an essential part of the process. Usually this is the selling of a property and, where the sale falls through for whatever reason bridging lenders can find themselves caught between a rock and a hard place. The failure of the exit strategy is also worth considering because selling a property depends upon factors outside of your control, such as the state of the housing market. Whatever your exit strategy is, it would be wise to consider a contingency plan should that situation arise, which may involve extending the finance. Correctly planned finance always factors in enough financial space for whatever eventuality arises.
Breaching the Terms of Your Bridging Loan
It’s worth stating that commercial bridging finance is, as yet, unregulated in the Utah and this means that lenders are at liberty to insert their own terms and conditions. You need to read the fine print very carefully before signing on the dotted line to understand what the fees, payments and charges are, and when they’re due. You also need to understand what the agreed terms of the loan are ensure you do not breach them. Many lenders prohibit the renting of a property while it is waiting to be sold for example, so borrowers who choose to rent their property without realizing this might risk property repossession. Credit scores are affected by the number of recent applications, so if you were to apply unsuccessfully for a loan it would be indicated on a subsequent credit check, unless a period of time elapses. Bridging loan providers are less concerned by particular credit ‘scores’, however, as compared with mortgage lenders. Obviously, companies with good credit are more attractive to lenders but it is certainly possible to obtain bridging with credit issues in place.
To Minimize Risks, Check the Fine Print
Perhaps the biggest risk with bridging finance is to enter into an agreement that may hold surprises for you. Since many people seek bridging loans in a state of urgency, perhaps chasing a particular property deal, it can be too easy to race through the process without doing your due diligence.
Pros of bridge loans
Aside from being able to secure the home you want when you want it, there are other perks to bridge loans.
If interest rates are low when you get the bridge loan and you’re ready to buy your new house right away, then you can lock in that low rate on your new home’s mortgage without waiting for your existing place to sell.
Moving is one of the most stressful life events; who wants to go through it twice? “Sometimes what you have to do is sell your house, move to an apartment, buy another house, and then move again. A bridge loan helps avoid that.” With a bridge loan, you can buy your next home and move immediately. If you have to wait to sell your current home before buying your next home, there’s a chance you’ll end up having to move into a temporary spot and put your stuff in storage. That’s just an extra headache.
Because bridge loans are secured with real estate, they usually get approved and funded very quickly.
Having a bridge loan can make your offer more attractive to a seller; it is one less sales contingency they have to worry about.
Cons of bridge loans
As appealing as bridge loans may sound, there are some negative factors to consider.
In order to secure a bridge loan, you need to have good credit and a low debt-to-income ratio; there is little wiggle room here.
Most bridge loans come with origination fees such as administration fees, escrow fees, wiring fees, notary fees, and title policy fees. Those fees can be high and are usually a percentage of the loan.
If your current house doesn’t sell, you still have to pay the bridge loan. That means you’re on the hook for three payments: your current home, your new home, and your bridge loan. Having these three huge financial obligations increases your likelihood of defaulting on one of those loans.
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