How Does Bridging Finance Work?
Bridging finance is designed to provide quick fund access and bridge the gap between one financial obligation and another. It is a useful tool for people in various situations who need immediate access to cash.
This article explores vital topics, including how bridging finance works, the different bridging loan options available, and the process you must go through to secure one. Whether you’re a borrower or an investor, understanding how bridging finance works can help you make informed decisions about your financial future.
Bridging Finance Loan In A Nutshell
A bridging finance loan is a type of short-term financing typically used to bridge the gap between purchasing a new property and selling an existing asset. Bridge financing or a bridge loan is usually secured against the property being purchased, meaning the lender will hold a charge over the property until the loan is repaid. The lender will also provide financing for the purchase of the new asset.
As such, this funding option can be useful for individuals looking to buy a new property but have yet to sell their current property. Property developers who must finance a new project while awaiting payments can also consider bridging loans. Getting a bridging loan for buy-to-let deposits can also be helpful for rental property investors.
Understanding Bridge Financing Loans Further
Lenders have different terms and eligibility criteria for bridge financing. Generally, the amount that can be borrowed will depend on several factors, including the value of the property being purchased and the borrower’s credit history and ability to repay the loan.
For example, if you want to purchase a new property for USD$ 300,000 but have yet to sell your current property, which has a balance of USD$ 200,000. In this situation, you may obtain bridge financing worth USD$ 500,000 to cover the purchase price of the new property and the payable from your current asset. This is called peak debt.
The peak debt must be repaid within a short period, typically between six and 12 months. During this time, you will be responsible for paying the interest on the loan, which can be quite high compared to other types of financing.
After selling your current property, you can use the proceeds from the sale to repay your bridging loan. The remaining debt, also called the end debt, must be repaid like a mortgage. If you can sell your property quickly and at a good price, you can repay the loan within a few months. However, if your property takes longer to sell or you’re unable to sell it for the desired price, you may need to extend the loan or refinance it with another lender.
Bridge Financing Options
One of the key benefits of bridging finance is that it can be arranged quickly, often within a matter of days. This can be particularly useful in situations where a property purchase needs to be completed quickly or where other types of financing aren’t available.
The following are some of the most common types of bridging finance options available to borrowers.
1. Open Bridging Loans
Open bridge financing is the most common type of bridging loan. It’s a short-term loan secured against a property’s value. Open bridging finance doesn’t require a strict exit plan or repayment period, but the debt must be repaid within a year. Borrowers who have yet to sell their property often opt for this financing type.
2. Closed Bridging Loans
Closed bridge financing provides an alternative option for borrowers with a clear exit strategy. It involves a lender providing capital for a set amount of time, such as six months, and the borrower needs to have a pre-determined plan for how they will repay the loan at the closing period. This option is ideal for individuals who have completed a property sale but are waiting for payments.
3. First Charge Bridging Loans
First charge bridging loans are available when the property being used as collateral has been fully paid off by the borrower. If the borrower defaults on the loan, the lender will repossess the asset and sell it to recoup the amount in question.
4. Second Charge Bridging Loans
On the other hand, a second charge bridging loan involves using an asset as collateral that’s encumbered or has an existing mortgage. This financing type carries a higher risk of default and interest rates.
In general, bridge loans can be more expensive than other types of financing due to the short-term nature of the loan and the higher risk involved. If borrowers cannot repay the loan on time, they may risk losing the collateral.
Similarly, lenders have different bridging loan products catering to the specific needs of individuals or business organizations, and the associated costs and terms vary widely. Seeking professional advice and understanding how bridging finance works can help you make the best decision.
Processes Involved In Bridging Finance
While securing a bridge loan may seem complicated, the process is actually quite straightforward. Here are the steps involved:
- Initial Assessment: Lenders need to understand the borrower’s purpose for taking out a bridging loan and assess their ability to repay it. This process typically includes a credit check and reviewing the borrower’s financial history.
- Application Processing: The borrower must submit documents proving their identity, income, and asset ownership. This information helps banks and lenders verify the borrower’s financial situation, evaluate eligibility, determine the risk score, and set the loan amount and interest rates.
- Loan And Term Approval: If the loan is approved, the lender will provide the borrower with a loan agreement outlining the loan terms and any applicable fees. The borrower must understand the loan terms and sign the loan agreement to finalize the transaction.
- Disbursement of Funds: Bridging finance is usually provided quickly, with the funds typically available within five to ten business days.
- Loan Repayment: Before signing the loan agreement, it’s important to understand the bridging loan repayment terms and options to ensure you can meet your financial obligations.
Bridging finance products are offered by banks, private lenders, and other traditional and non-traditional financial institutions. Since multiple bridge financing products are available, it’s important to compare them to find the best terms and lowest interest rates. You may also approach brokers, but you’ll have to pay them for their service.
Whether an entrepreneur, investor, or homeowner, accessing bridging finance can be an important tool in your financial toolbox when used appropriately. It can help you bridge the gap when you need to move quickly and can’t wait for traditional financing.
But this loan option is by no means perfect. Understanding how it works, the different bridging finance options, and the process and risks involved, are important before getting one. With the right information, you can use bridging finance to help you secure the necessary funds to develop a robust financial future.