Advantages and Disadvantages of Bridging Finance
A bridging loan or “bridging finance” is a short term loan, typically taken for a short period between 2 weeks and 12 months with a view to moving to longer term financing or exit strategy.
Bridging loans are generally used in property purchases / acquisitions when a decision needs to be made quickly. Bridging loans can help too:
- Stop property getting repossessed
- Take advantage of a short term opportunity
- Purchase your dream home whilst you wait for your current home to sell
Bridging loans are generally repaid when a property has sold or alternatively refinanced through a traditional lender. A bridging loan is known in the lending market a non-standard loan as its a short term loan with unusual circumstances.
Bridging loans in the UK can be used not only for property, but also for businesses too. For businesses, bridging finance is generally used when a company requires additional funds to help boost its cash flow or for acquisition purposes. Bridging loans for property can be used to break property chains and provide a short term finance solution where there is a delay between sale and completion dates. Another typical reason why bridging loans are taken in the UK is when properties are purchased at auction, additionally developers & landlords can use bridging finance for development or renovation purposes.
The History of Bridging Finance & Bridging Loans
Bridging finance is known within the lending market as a unique and specialist product and this type of lending, although having been around for a while became very popular in the recession in 2008. Gross lending more than doubled from £0.8 billion in March 2011 to £2.2 billion in June 2014 (Wilkipedia).
During this same period the high street banks / mortgage lenders were becoming ever more reluctant to lend or even grant mortgages in the UK. This opened the floodgates in some ways and really gave the bridging market an opportunity to take a market share in UK lending.
Bridging started to become quite popular during this period, but as the interest improved so too did the watchful eye of the Financial Services Authority, now better known as the FCA (Financial Conduct Authority). The FCA subsequently warned UK homebuyers & homeowners of the disadvantages of bridging finance and that it didn’t provide a substitute for normal mortgages issued by building societies or high street banks. The FCA main issue is that it felt that mortgage brokers were promoting the bridging finance products to unsuitable clients which resulted in a default of the loan.
The bridging market was enforced in 2011 by West One Bridging Index and this has helped push the popularity of bridging finance and has seen monthly interest rates reduced by the majority of the main stream bridging lenders.
What are the Characteristics of Bridging Loans?
The typical terms for bridging finance over a 12 month period is around a 15% interest rate for the year (1.25% a month). Loan to value on properties generally don’t exceed 65% for commercial properties (offices, retail, industrial) or 80% for residential properties based on a market value.
A bridging loan maybe either closed (with an arranged timescale for the loan period to end) or open (no fixed timescale for completion of the loan). Open bridging loans are generally riskier as there is no clear timescales and this means there is a greater chance of default.
The majority of the lenders involved in the bridging finance sector will only offer first charge bridging, and this attracts a higher loan to value (LTV) than a second charge bridging loan, generally because the perceived risk is lower. This isnt to say that bridging finance lenders wont offer second charge bridging, but those who do it will apply higher interest and LTV rates.
Bridging finance generally isn’t regulated.
Advantages of Bridging Finance
- One of the biggest advantages of bridging finance is that it is finance strictly over a short term period. If you compare a bridging loan against a mortgage from a bank or building society, a mortgage is geared as a long term financing product which obviously attracts long term expenditure. Bridging finance can be arranged from as little as 1 week up to 12 months.
- An advantage of a bridging loan is that your credit profile can be improved significantly if you make all of your repayments on time.
- Advantages of bridging loans is that it enables you to purchase a property quickly. A bridging loan through a mortgage lender is typically completed within 2 weeks, compare that to a residential mortgage (average 2.5 months), there is no real comparison
- Bridging finance can be secured quickly to purchase a property, with a view to getting longer term finance when you are ready.
- A guaranteed quick house sale, with no broken chains or mortgage offers been pulled by lenders.
- Advantages of bridging finance is that the bridging loan effectively makes you into a cash buyer, which in turn can improve your negotiating power for your onward purchase.
Disadvantages of Bridging Finance
- The primary disadvantages of bridging finance is its incredibly expensive. The cheapest rates in the lending market are generally 1% per month (some lenders are 1.5% per month) on the money borrowed. Due to the bridging loan been a short term financing method, this subsequently means the interest repayments are much larger compared to a long term financing product.
- Disadvantages of bridging loans is that a large number of these end up in default due to the excessive interest rates been charged. Bridging lenders aren’t flexible when it comes to late payments. Lenders typically charge larger fees, interest rates and penalties when payments are late which results in the borrower not been able to repay the loan.
- For every month a bridging loan isn’t repaid, this gathers compound interest. This means the repayments will become substantially larger if the borrower didn’t make payments during the loans terms.
- The major disadvantages of bridging finance is that it relies on the borrower been able to secure longer term finance. This is never guaranteed and we saw this a lot in 2008 – 2012 where lenders got into financial problems and funding was withdrawn resulting in the borrower unable to get out of the bridging finance, which fundamentally results in a default of the loan.
- If you default on your bridging loan, your credit profile will become adversely affected. Bridging finance remains a lending product not for the faint hearted and unless you have deep pockets, this type of financing isn’t suitable the majority of times.
Seek Independent Financial Advice
Good Move recommend anyone who is considering using bridging finance to consider all options, for this reason we recommend you seek independent financial advice from an experienced mortgage broker. Property is an expensive asset class and its well worth spending the extra time undertaking thorough research into bridging finance. Whilst there are advantages and disadvantages of bridging loans, its imperative that the situation you are in is right for this short term risky finance product. Good Move recommend speaking to experienced mortgage brokers such as Mortgage Advice Bureau, who have a great understanding of the bridging market and best interest rates.
This blog has demonstrated that there are a number of advantages and disadvantages of bridging finance. Here at Good Move we wouldn’t recommend bridging finance generally as its a risky strategy and can result in extortionate interest rates been charged for short term finance, with possible defaults.
If you need to avoid house chains, stop your home getting repossessed or generally need to raise some equity quickly, have you not considered selling your house quickly with GoodMove? Good Move is a chartered surveying firm, regulated by the RICS (Royal Institution of Chartered Surveyors) & the NAPB (National Association of Property Buyers) and we can orchestrate a quick cash sale of your property within 2 weeks or in a timescale to suit you. In addition to the sale, we pay your legal fees and there are no expensive estate agency fees to pay! If this could be of interest, contact our sales team on 0800 8021175!
We hope you enjoyed the blog!