What is a Bridge Loan?
Bridge loans are an option for many homeowners currently stuck in limbo, providing them with a way to purchase their next home without being held back by the sale of their current property. Explore the ins and outs of a bridge loan and find out if it’s a suitable option for your current situation, below.
What is a bridge loan?
A bridge loan is a specific kind of short-term loan, typically taken out by a person or a company to provide a temporary solution to an immediate financial obligation. Bridge loans usually last no longer than a year, and are known for having high interest rates.
Bridge loans may be used for a number of reasons, but are most common in the world of real estate. Bridge loans can help homeowners who are ready to move but can’t find a buyer for their existing home, or those who are waiting for the exchange of contracts to complete.
Bridge loans provide buyers with the cash to continue with the purchase of a new home, while waiting on funds from the sale of their current property. They essentially ‘bridge’ a monetary gap between a house sale and purchase, so chains remain unbroken and homeowners don’t lose out on their next home.
What different types of bridge loans are available and how do they work?
There are two major types of bridge loan available: a closed bridge loan and an open bridge loan. Discover the difference below.
Closed bridge loan
Closed bridge loans require applicants to know exactly how, and when, they plan on paying off the money they owe. For example, if your current property already has a set completion date, or you have a fixed date for your mortgage agreement, then you will be eligible for a closed bridging loan.
Borrowers will be able to set a concrete repayment date with their lender during the application process, as they will know exactly when the funds needed to pay off the loan will be available. This degree of certainty will give a lender confidence and reassurance, and often leads to a higher acceptance rate, alongside a lower interest rate. However, it’s important to note that missed payments for closed bridge loans can come with significant financial penalties.
Open bridge loan
You should choose an open bridge loan, however, if you do not know when funds will become available. Open bridging loans have no set date when it comes to repayment, and offer a greater sense of flexibility to homeowners.
Choosing an open bridge loan will mean you will not face the financial penalties that occur when missing a closed bridge loan repayment. However, due to the uncertain nature of an open bridge loan, higher interest rates will apply to counteract the risk taken by lenders. The short-term nature of a bridge loan will also mean a repayment is typically expected within a year.
What can a bridge loan be used for?
Bridge loans are frequently required for matters of real estate, however there are many other reasons borrowers may wish to apply for them. The most common reasons people apply for a bridge loan include:
- Buying a property
- Buying a property at auction
- Initiating property development (e.g. buying land)
- Investing for buy-to-let purposes
- Refurbishing a property
- Buying a dilapidated property for renovation
Advantages and Disadvantages
If you are thinking about taking out a bridge loan, it’s important to consider the advantages and disadvantages first to help you make an informed decision. The crucial thing to remember about a loan of any kind is that it should be a last resort, and only for those who are confident they will be able to repay it.
- Short-term solution: One of the biggest advantages of a bridge loan is that it’s only available over a short-term period. Whereas long-term financing products like a mortgage encourage long-term expenditure, bridging loans can be arranged from as little as one week up to 12 months.
- Credit profile:Your credit score can be significantly improved if you take out a short-term loan and make all the repayments on time. This will help any applications you make for financing in the future, as the lower your credit score is, the less likely you are to be approved.
- Quick house sale:A bridge loan through a mortgage lender is typically completed within two weeks, whereas a residential mortgage takes on average two to three months to secure. The sale is also guaranteed, with no broken house chains or mortgage offers revoked by lenders.
- Flexible repayment:Although a closed bridge loan has a fixed repayment date, there’s nothing to stop you paying back the loan before then and saving on the interest rates. If you’re unable to make monthly interest payments, you can choose to pay it back at the end of the term instead.
- Incredibly expensive:The main disadvantage of bridging finance is that it’s very expensive. The cheapest interest rates in the lending market are generally 1.5% per month, but due to the short-term nature of a bridge loan, the interest repayments are much higher compared to a long-term finance option.
- Compound interest:For every month a loan isn’t repaid, it gathers compound interest. This means that you’ll end up paying more interest in total than you would if you rolled it up, as your loan amount is increasing month-on-month.
- Credit profile:If you default on your bridge loan, your credit score will be adversely affected. A large number of loans do end up in default due to excessive interest rates and lenders being inflexible when it comes to late payments.
Applying for a bridge loan
Before applying for a bridge loan, you need to make sure you have a clear exit strategy in place – otherwise, you will not be accepted. Lenders will often consider several exit strategies, including:
- Sale of the primary property
- Sale of other investments
- Refinance to a longer-term mortgage
- Sale of a secondary property
- Sale of shares
When it comes to actually applying for a bridge loan, you will need the following documents:
- Proof of ID (and potentially proof of residency)
- Proof of exit strategy (as mentioned above)
- Proof of income
- A valuation report: the majority of lenders will conduct this report for you, using their own surveyors. Some may also ask you to pay the fee – so be sure to check in advance.
You may also be asked to provide a business plan, if the property you plan to purchase is not for personal use, or evidence of your experience in the property market if you are buying a property to develop.
Interest rates and fees
As mentioned, bridge loans have high interest rates – much higher than standard mortgage rates. The majority of lenders will offer up to 70% of the property value as a bridge loan, however some may consider 75% or 80%.
The exact interest rates of a bridge loan will be determined by three things: the loan-to-value ratio, the type of property (commercial or residential) and the risk to the lender.
The typical terms for bridging finance over a 12-month period are around a 15% interest rate for the year, or 1.25% a month. This will vary, however, depending on the lender you choose. Loan-to-value on commercial properties generally doesn’t exceed 65% for commercial buildings and 80% for residential properties based on the market value.
Just like interest rates, bridge loan fees will vary depending on how much is borrowed, and the lender selected. However, borrowers should expect to see the following fees when taking out a bridge loan:
- Administration fee
- Appraisal fee
- Escrow fee
- Title policy fee
- Wiring fee
- Notary fee
- Loan origination fee
Bridge loans aren’t for everyone, and they do come with risks. The longer you wait to sell your current property, the more interest you will be required to pay. Other options available include remortgaging or taking out a personal loan.
Another alternative method, which will ensure you can sell your house fast and continue with the purchase of your next home, is to use a reputable direct cash house buyer like Good Move.
At Good Move, we can ensure the sale of your property in 21 days or less – we can even sell a home within 7 days, if necessary. It doesn’t matter about the condition of your home either; we have immediate funds to buy all properties – including those classed as problem properties – for up to 85% of market value. Simply get in touch today to receive your no-obligation quote.