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Types of Bridging Loans
Closed Bridging Loan
A closed bridging loan is suitable for individuals or real estate property developers who have a guaranteed funding source within a set time frame. The borrowers of this type of bridge loan have a predetermined exit strategy or a tenable repayment plan.
Imagine you’re in the predicament of having to sell your current property before purchasing a new one. You’ve set your eyes on the new property but have not been able to finalize the sale of the old one. In the cutthroat real estate industry, it doesn’t take much to throw buyers into competition with one another. There could be a number of people vying for one property, and having contracts in place may not matter if someone has more cash readily available and is content to pay full price without haggling.
In the case above, your lender fronts you the loan to pay for the new home and recoups their money on the set date of the completion of the sale of your current home. A closed bridge loan is more agreeable for most lenders because it carries lower risks. As a consequence of the relatively lower risk, the interest rates are also lower than those of other bridging loans. Besides paying the debt through the sale of your property, you could also take out a mortgage on your new property.
As a real estate company, a closed bridging loan is favourable because all property types can be used as a form of security. Whether your company deals with apartments, maisonettes, or development land, you can use these assets to secure closed bridging finance.
Open Bridging Loan
An open bridging loan hedges you from penalties in the case of unforeseen circumstances such as complications from legal procedures, which may slow down the transaction. This form of money lending is different from closed bridging loans. Once you state the specific date of repayment in a closed bridge loan, dishonouring the debt repayment schedule results in penalties.
Typically, the loan term of an open bridge loan is as implied “open”, and could go well over a year. Given the risk associated with the lack of a predetermined exit strategy, the bridging loan rates are more than those of a closed bridge loan. So, if you are uncertain of the date you will have your funding available, open bridging finance could be the right finance option for you as an individual or a company. However, financiers in the market might be less willing to advance these kinds of loans due to the risk exposure for them.
First Charge Bridging Loan
For example, if the borrower defaults at the end of the loan period, the lender can sell off the property to settle the deficit. If there are other loan obligations attached to the property, the first charge lender holds priority over other lenders.
The first charge lender has a limit on how much money they can advance against the property. For example, the lender could set the limit at 80% of the overall value of the property. This allows them to recover what the borrower owes them and their losses from the property value. Therefore, a first charge loan offers a degree of security to the lenders thus has a lower interest rate. A majority number of financiers prefer being the first charge to reduce the risk of default.
The remainder of the equity can be used to take out a second charge loan depending on the necessities of the individual or company. This type of bridging loan can be used for a number of situations, such as the purchase of an investment property in cases where it’s time-sensitive or to complete renovations.
For residential property in the UK, the Financial Conduct Authority offers regulation. However, the FCA doesn’t regulate any loans or mortgages used to purchase commercial or business-related real estate assets.
Defaulting on a first charge bridging loan can result in the repossession of property, or one can be forced to renegotiate the terms of the loan, which results in higher interest rates or loss of property. Bridging loans are short term financial solutions thus should be used carefully when getting a long term financial strategy.
Second Charge Bridge Loan
People can take out a second bridge loan on properties that already have a loan or mortgage outstanding. Once a company or an individual takes out a first charge loan, the lender leaves a small portion of equity on the property’s value, which the second charge loaner uses for loan valuation.
For example, if the property requires some renovation or you need to add an extension but lack enough funds, then this kind of loan would provide a solution. You can take out a second bridging loan on a property with another outstanding loan or mortgage if there’s enough equity left on the asset after the first loan.
A second charge loan is appealing because it has an easy and fast processing procedure similar to the other types of bridging loans. It helps to have a good credit score, but it’s not a requirement on this type of loan. Further, it’s available for both residential and commercial properties. It is important to note that you need to have authorization from the first charge lender to proceed with the acquisition of the second charge bridge loan. Additionally, the second charge lender cannot collect on their debt until the first charge lender has fully recovered their investment. All the same, they both possess equal repossession rights in the event of a default in repayment.
Once you complete the project, renovations or extension works, you can move the debt to become a secure loan with lower interest rates. However, the risk factor for defaulting on the debt for the financiers is more, so many of them tend not to offer this type of bridging finance.
Bottom Line on Bridge Loans
Bridging loans are an attractive financing option to meet short-term needs. Bridge loans provide financial ‘bridges’ before borrowers are able to secure other forms of funding. Property developers and individuals find bridging loans appealing to use for various reasons. One major reason is that it’s easier to work around the red tape with bridge loans than it is with conventional loans. For example, even with a less desirable credit rating, using your property as collateral, you can still access different types of bridging loan.
The processing period of a bridging loan is much quicker than that of a conventional loan, making it ideal when buying property at an auction, buying a second house before selling the first one, or when developing property before full capital is available to cover inventory costs. Bridging finance is attached to the value of a property as opposed to the purchase price. A bridge loan can also be attached to a property that’s less desirable to other conventional lenders.
Whilst all types of bridge loans are designed to offer short-term finance solutions, each type of bridging loan has a different loan term. The bridging finance rates differ with lenders, and you can calculate them on a website using bridge loan calculators. Due to the short repayment period of the loan, the interest payments can be high, and you require the advice and guidance of a bridging loan broker with experience in financial services and bridging finance. Regardless of the circumstances, you need to choose the right type of bridging loan.
You also need to conduct due diligence because some bridging loans are unregulated, so you need to ensure that you have all the information to avoid a punitive exit fee or other hidden charges like a broker fee or a lender arrangement fee.