If you need to borrow money for a short term, a bridging loan (or “bridge loan”) may be handy. For example, it can “bridge the gap” if you wish to purchase a new house before selling your current one.
Bridging loans can also be utilized to purchase a property at auction if you need the funds immediately but have not yet sold your existing home.
This tutorial explains how bridging loans operate and who may qualify for them.
How does a bridge loan function?
There are two types of bridge loans: open and closed.
Closed Bridge Loans
A secured loan has a defined repayment date; you will typically be awarded this type of loan if you have exchanged contracts but are still awaiting the closing of your property transaction.
Open bridging loans
With an open loan, there is no fixed payback date. However, the loan must typically be repaid within a year.
The lender will require evidence of a transparent repayment scheme, such as leveraging equity from a property sale or taking out a mortgage, regardless of the type of loan you seek.
In addition, they will require evidence of the new property you plan to purchase, the price you intend to pay for it, and proof of your efforts to sell your current home, if applicable.
Additionally, you should have a backup plan if your repayment approach fails.
What are primary and secondary bridge loans?
When you obtain a bridge loan, your property will be subject to a ‘charge.’ This formal contract specifies which lenders will be reimbursed first in the event you default on your loans.
Both a first and second charge is pending. If you default on your bridging loan, your property will be used as collateral.
If you still have a mortgage on your house, the bridging loan would often be a second-charge loan, meaning that if you defaulted on your payments and your home was sold to pay off your obligations, your mortgage would be paid off first.
However, if you owned your home or were taking out a bridging loan to pay off your mortgage in full, you would obtain a first-charge bridging loan. If you were behind on payments, the bridging loan would be repaid before any other debts.
How much do short-term Loans cost?
People typically take out bridge loans for a limited period. Hence they are charged monthly rather than annually.
One of the most significant disadvantages of a bridging loan is that it may be pretty expensive, with costs ranging from 0.5% to 1.5% per month.
This makes them considerably more expensive than a typical home mortgage. In addition, the corresponding annual percentage rate (APR) on a bridge loan ranges from 6.1% to 19.6%, significantly higher than the APR on typical mortgages.
It is suggested only to obtain a bridging loan if you are convinced you will not need it for an extended period, as set-up fees are typically around 2% of the loan amount.
What is the Maximum Loan amount for a Bridge loan?
In terms of cash, bridge loan lenders may lend between £25,000 and £25 million.
However, you will often be limited to a maximum loan-to-value ratio (LTV) of 75% of your property’s worth.
Typically, you’ll be able to borrow more with a first-charge loan than with a second-charge loan.
What Alternatives exist to a Bridge Loan?
If you wish to relocate but cannot sell, you could potentially explore a rent-to-own mortgage.
This can be accomplished by refinancing your present home onto a buy-to-let mortgage and using the equity to purchase a new property.