Should I apply for a bridging loan? Understanding the risks involved
When property professionals need to borrow money for short periods of time, there are a number of different options available. Typically though, a bridging loan can often offer a very convenient way forward. It’s designed to ‘bridge a gap’ — to give you access to the cash you need until a more permanent solution is put in place. But like all forms of lending, there are a number of risks involved that you should consider before making a decision. Here, we’ll take a closer look at what those risks are, and how you can plan around them.
When should you use a bridging loan?
A bridging finance arrangement is a secured, interest-only loan on a property. Like a mortgage, the property is at risk of repossession if the loan isn’t paid back in time. But unlike a mortgage, the loan is for a short period of time (from a few weeks or less, up to usually no more than a year). And instead of paying back the capital and interest in monthly instalments, you usually pay it back as one lump sum.
Here’s a roundup of the key features of a typical bridging loan:
It’s open to a wide range of property professionals: this includes sole traders, limited companies and partnerships. Bridging loan lenders are often a lot more accommodating than traditional banks; they can consider applications on a case-by-case basis — including where there is a history of bad credit.
Quick lending decisions: there is still a credit check and property value assessment to go through. However, the eligibility and approvals process for bridging loans tends to be significantly quicker compared to traditional banks. They can often be arranged within a matter of days; something that’s crucial where you need access to finance in a hurry.
Suitable for a wide range of finance requirements: this includes the classic broken or delayed chain scenario; i.e. where you temporarily require capital for a purchase, to be repaid when the linked sale is finalised and the equity from that property is released. It also includes funding the initial deposit for an auction purchase — or paying for initial refurbishment so that a distressed or dilapidated property meets the mortgage lender’s specifications for longer-term financing.
Risks associated with non-payment
Late or non-repayment will give rise to penalty interest charges and in the most serious cases, repossession of the property. To avoid this, you should allow yourself some leeway when arranging the loan. This might involve setting the fixed repayment date a day or two after the completion date on your linked sale, for instance. Or if the loan is to cover refurbishment and you think the property will be ready to go on the market in 3 months’ time, perhaps allow 6 months for the loan period to allow for snags and minor delays.
Breach of conditions
Like any borrowing arrangement, if you breach the conditions, it opens up the possibility of penalty charges — and even of cancellation of the arrangement with immediate effect.
As an example, if your exit plan involves the sale of a commercial property following refurbishment, the lender may insist that you don’t let out all or part of the property while the works are underway. There’s a good reason for this, as sitting tenants can delay a sale if they fail to vacate in time.
This is why it’s important to read the terms of the arrangement carefully before entering into it, so you fully understand your obligations.
The importance of a realistic exit strategy
The clearer you are on your exit strategy, the lower your risks. You don’t necessarily need to know the exact date on which you’ll be able to pay everything back (after all, that’s where open loan arrangements can help you). However, you do need to be able to identify a clear path for repayment, whether it’s through the sale of the property, refinancing to a longer-term mortgage — or receipt of cash from another source (sale of another property in your portfolio, for instance).
At the same time, to get the best possible terms and a flexible arrangement tailored just for you, it helps if you have access to a bridging finance specialist. If you’re interested in learning more about how to make the most out of your property opportunities, browse our guide to property finance below or speak to West One Loans today.
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