The best way of explaining short-term bridging loans as a form of alternative finance is that they are an effective funding option that will run for days, weeks and up to one year – some lenders will have a two-year time limit.
They effectively bridge a gap between a debt falling due and having the money to pay for it.
Most people will be aware of bridging loans when buying a property, particularly when they are selling their own home but don’t have the money to buy their next property until the sale is completed and the money is in their account.
This means there is a need for a stop-gap measure that bridges the need between buying a property and having the money to pay for it.
For this reason, potential borrowers need to be aware that bridging loans tend to be slightly more expensive than a normal loan would be.
Bridge funding has a wide range of purposes
However, bridge funding has a wide range of purposes and are not just used by those buying a property and the range of uses has grown in recent years.
One reason for this is that mainstream lenders have tightened their lending criteria since the financial crisis which means there are growing numbers of bridging lenders entering what is a competitive market.
Along with the fact that bridging loans can be slightly dearer, borrowers will also need to pay an administration fee which will be a percentage of the amount being borrowed.
These fees will vary from 2% on amounts up to £150,000, for instance, while some lenders may offer a 0.5% fee on loans of more than £1 million. Again, these rates and amounts vary between lenders and it’s always worthwhile shopping around.
Among those who have been enthusiastic about bridging loans are property developers and landlords since they can access large sums of money in as little as 48 hours.
This is a positive reason for those who are buying property at auction, for instance, since they can bid on a property, pay a deposit and then find the balance within the 28 days’ deadline.
One reason for this is that bridging lenders look for security for their loan, generally in the form of property with equity in it.
Use a bridge loan to develop a property
Along with buying property at auction, another use for a bridge loan is to develop a property for selling on quickly or to access a mortgage once the property has been renovated.
So, while mainstream lenders may take weeks or months to process a loan application, a bridging finance lender may be able to deliver large sums of money to the borrower’s bank account in just a few days.
A lot also depends on the purpose and size of the loan since there may be a need to have a valuation of the security being put forward. This is a fee the borrower will need to pay.
Another big appeal for bridging loans is that they can be used to suit a range of circumstances and the borrower may not have to pay interest on the money until the loan falls due.
This is known as ‘rolling-up’ when the interest and loan will be repaid at the same time.
The potential bridging finance borrower will also need to know how and when they will be able to repay their loan and the lender will refer to this as an ‘exit route’.
A ‘closed’ bridging loan
This boils down to two solutions: the first is to know when the loan will be paid and this will be known as a ‘closed’ bridging loan. For instance, the borrower will know when their house sale proceeds will be in their bank account.
The other solution is known as an ‘open’ bridging loan which is when they do not know when the money will be available to repay the loan.
As mentioned previously, bridging loans are particularly popular for those wanting to buy property and develop it.
However, there’s also a growing need among businesses to access short-term finance solutions and bridging lenders offer a wide range of solutions for them.
Among the loan purposes may be to buy stock for a promotion, for instance, or to refurbish their premises or offices. There may be a desperate need for new equipment or they may have a client who has not paid an invoice.
This impact on cash flow means there is a need for a quick input of cash and when the invoice is paid then the business will be able to repay their bridging loan.
Bridging loan lenders will offer loans for different purposes
It should also be appreciated that differing bridging loan lenders will offer loans for different purposes, they will also have differing rates of interest on the amount being borrowed and differing loan to values (LTVs).
While this may appear to be confusing, it does underline just how flexible bridging loan lenders are in meeting the needs of those who are looking for short-term financing requirements.
This is why it pays to shop around to find a bridging lender who meets the borrower’s needs and they will also need to take into account things like administration and valuation fees. Some borrowers may also have to pay legal fees for their loan to be processed.
Again, because of the short-term nature of bridging finance, they tend to be more expensive than mainstream loans but they are more flexible and can be used for a wide range of purposes and lenders have different criteria when looking at the borrower’s ability to repay.
While the borrower’s credit history will be taken into account, the purpose of the loan and the value of the security will also have a big impact on how a lender views a borrower’s ability to repay.
When it comes to understanding short-term bridging loans as a form of alternative finance, it will be time well spent speaking with the team at the Bridge Crowd for more advice and information.