Bridging loans are a short term funding option. They are used to ‘bridge’ a gap between a debt coming due and we’re talking primarily about property transactions, here and the main line of credit becoming available. Or they can simply act as a short term loan in pressing circumstances.
They can be invaluable in facilitating a property purchase that otherwise would not be possible. But as you might expect with a stop gap measure, they can be significantly more expensive than a ‘normal’ loan.
What are bridging loans and how do they work?
Bridging loans are designed to help people complete the purchase of a property before selling their existing home by offering them short term access to money at a high rate of interest.
As well as helping home movers when there is a gap between the sale and completion dates in a chain, this type of loan can also help someone planning to sell-on quickly after renovating a home, or help someone buying at auction.
As banks and building societies have grown more reluctant to lend in the wake of the financial crisis, there has been an influx of bridging lenders into the market.
However, rates can be high and there can be hefty administration fees on top. Indeed, potential borrowers are warned there is a risk of getting ripped off unless you proceed extremely carefully.If you take out a bridging loan, you could face costs of up to 1.5% a month meaning 18% a year.
Generally speaking, bridging loans are aimed at landlords and amateur property developers, including those purchasing at auction where a mortgage is needed quickly.
They may also be offered to wealthy or asset rich borrowers who want straightforward lending on residential properties.
When should you use bridging loans?
Bridging loans can be used for a variety of reasons, including property investment, buy to let and development.
However, more recently, there has been a growing trend among borrowers to use bridging loans because high street and private banks are taking longer to process applications for larger home loans.Some borrowers are also viewing bridging loans as a simple alternative to mainstream lending.
While a bridging loan may sound tempting, if you’re thinking about taking one out, you need to think carefully about your exit strategy. This might, for example, involve getting a mainstream mortgage or a buy to let mortgage, or selling the property altogether.
The problem is, you may not have any guarantee of being accepted for a mortgage with a mainstream lender after having taken out a bridging loan. This could put you at risk of losing your home.
The FCA is concerned that advisers could be recommending this type of loan too quickly when it may not be the best solution.
Crucially, if you’ve not used this type of finance before you need to tread carefully, as there are often hidden and hefty legal fees and additional administration fees that are not always made clear.
All of these mean the cost of your bridging loan could soon mount up.Put simply, bridging loans should not be viewed as an alternative to mainstream lending.
If you want to take out a bridging loan, it’s advisable to go to an FCA-regulated broker because they will only recommend a bridge if it is appropriate for you and your particular circumstances.