bridging loans explained - part 2 of 6
As short-term financing options, bridging loans can repair or stabilise broken property chains. This can make it possible for you to purchase a new home before your current home sells. It can also allow you to buy land or develop a commercial property while you wait for another type of funding. Bridging loans help many people finance property sales transactions that might otherwise be impossible for them to complete.
4) How Does a Bridging Loan Work?
Bridging loans
As mentioned in the previous article, there are two different types of these loans, open bridging loans and closed bridging loans. There is no definite end date for an open bridge loan. They usually last for one year or somewhat longer. You have the option to repay this loan as soon as you obtain funds from your long-term lending sources. A closed bridging loan, however, does have a definite end date. This end date is fixed as the date when you know your longer-term funding will be available. Closed bridge funding may last for only a few weeks or months. Since they are more flexible, open bridging loans are often more costly than closed loans.
Whether you obtain an open or closed bridging loan, you must have an exit route, or a method of repaying your loan. This is a major step in understanding, “How does a bridging loan work?” Monthly interest on your loan is charged by your bridging lender. Your lender will not quote an annual percentage rate (APR). This is because your loan may last for only a few weeks or months. Interest is usually charged on bridge financing in one of these three ways:
- Monthly Interest. The interest due each month is not added to your loan balance due. Instead, you pay the interest amount due each month. You will then repay the loan balance at the end of the loan term.
- Rolled Up (Deferred) Interest. With this repayment method, you pay the total interest due at the term’s end when you repay the original loan amount. No monthly payments are due. However, the interest is added to the loan balance each month.
- Retained Interest. When this method is used, you borrow the interest at the same time that you make your loan application. This will cover the amount of the monthly interest charges, typically for a set period of time. At the end of your loan term, you repay everything that you owe (principal and interest).
Some lenders will allow you to combine these methods. For instance, your lender may retain the interest amount over the initial six months. After this period, you pay the interest each month.
You may take out a first or a second-charge bridging loan. When you receive your loan funds, a charge is placed on your property. This legally designates which lenders will receive repayment first if you do not repay your loans. Both first and second-charge bridging loans require that your property be used as the security against your default on making repayments. If you currently have a mortgage on your property, your bridging loan is a second-charge loan.
This means that if you do not make your loan repayments and your home property is sold to pay this debt, your mortgage will be repaid first. However, if you own your property completely or your bridging loan is for the purpose of paying off your mortgage, your bridging loan is a first-charge loan. In this case, if you cannot make timely repayments, your bridging loan will be repaid first. After using this type of fast, efficient funding, you will no longer need to ask, “How does a bridging loan work?”
5) How Much Do Bridging Loans Cost?
Many property owners, sellers and buyers today ask, “How much do bridging loans cost?” Bridge financing can be expensive since these loans have both high interest rates and high fees. You need to be aware of the fact that when you obtain a bridging loan, you will pay fees as well as the interest that accrues. Fees charged include the following:
- Arrangement (Facility) Fees. These charges cover the expense of setting up and issuing the loan. They equal approximately one to two percent of the balance.
- Exit Fees. If you repay the loan early, these fees equal about one percent of the loan amount. Some lenders do not charge exit fees.
- Administration (Repayment) Fees. These charges cover the paperwork required throughout your loan term.
- Legal Fees. These amounts cover the lender’s legal fees and solicitor’s charges. They are typically set at a fixed rate.
- Valuation Fees. These fees pay the surveyor’s costs for the valuation of your property.
• Broker (“Introducer”) Fees. These fees are charged only if you engage the services of a broker. They cover the broker’s services for locating a suitable loan to meet your needs. Now you know the answer to the question, “How much do bridging loans cost?”
6) Are Bridging Loans Expensive?
One of the first questions that many potential property buyers or first-time builders ask when seeking short-term funding is, “Are bridging loans expensive?” These loans are known to have high interest rates and incur extra fees and charges. Whether or not these fees are costly for you is dependent on how much profit you will make on your real estate purchase or building project.
If you are planning to construct several multi-unit houses that can produce future annual profits for you of £1, 000,000, you can consider these charges as quite low-cost. Even if you are building a pair of single-family homes that will sell for £400k to £500k each, you will find these extra fees to be very reasonable. However, if you are applying for bridge financing to cover a funding gap when selling one home and buying another, you may want to consult a financial advisor first.
You want to be sure that the value of your current and future real estate assets will cover repayments of your bridging loan. If all else fails, you can sell your newly acquired property or apply for another type of funding to cover your repayments. However, with good planning and the advice of a financial expert, you can most likely repay your bridging loan while making a profit on your new property investment. A bridging loan can be either expensive or inexpensive relative to the level of profit you will gain on your property sales or building project.
Bridging loans explained - part 3
Don’t forget to read the other sections, for more information an help on understanding bridging loans and how they work.
If you need to understand how bridging loans work, or want help in securing a bridge finance loan, then get in touch.