What are Bridging Loans?
A bridge loan is a short-term loan, also considered as an interim loan for an individual or business till the permanent financing or next step of financing is approved or obtained and when the next stage of financing is obtained, it could be used to pay back the bridge loan as well as other capitalization needs, if any. While bridging loans are arranged faster and requires lesser documentation than any other loan, they are relatively expensive than the conventional loans because of higher interest rates and shorter time period.
Bridge loans are primarily used for property transactions and if you are planning to buy your new property before you could sell of your old one, bridging loans offer short-term access to money; however it comes with a high rate of interest. It is very beneficial when there is a gap between the sale and completion date of any sales or when you are planning to sell off your property after a renovation or if you want to buy something at an auction. These days bridging loans is getting popularity because banks and building societies are becoming reluctant to lend because of increasing financial crisis. Also, the processing time of conventional loan is more than that of bridging loan.
History of bridging loans goes back to 2008-2009 from the global recession when the gross lending was doubled from £0.8 billion in the March 2011 to £2.2 billion in June 2014, which was the same time when mainstream mortgage lending business saw a decline, as banks and building societies grew more reluctant to grant home loans. In the first quarter of 2016, the overall value of the outstanding residential loan amount was £1,304.5 billion which was at an increase from the fourth quarter of the year 2015 by 0.1% and by 3.4% from the previous four quarters and since 2011, the bridging market has been monitored by the West One Bridging Index, and has seen a regular and consistent increase in popularity and prevalence coinciding with a consistent drop in average monthly interest rates.
So, despite having high interest rates and administration cost, bridging loan is getting popular, mainly in real estate sectors. However, in case you are opting for one, make sure that your exit strategy is in place, considering high-interest rate and hefty administration costs.
How to Calculate Bridging Loan?
Bridging loans are mainly used for commercial real estate purchases in order to close on a property deal or by the builders to carry on with a project while permit approval is sought. Apart from real estate sector, bridging loans is used in venture capital and other corporate finance for various purposes.
1. Bridging loans in real estate: Bridging loans are quite famous and a common practice amongst property dealers, builders and even amongst individuals who want to buy one property before they could sell the other one. Mainly because it is easier and faster to get approved despite having. In a way, it is not very different from a hard money loan. Like a hard money loan, bridge loans are obtained on a short-term duration or unusual circumstances. Also, they are availed to deal with the current monetary issue and cannot be used to plan for future. Once the main loan is availed, it could be used to repay the bridge loan. In terms of real estate, bridge loans for up to 12 months, 2-4 points may be charged and loan to value (LTV) ratios does not exceed 65% for commercial properties and 80% for residential property, which is also based on the appraised value of the property in the picture. Various examples where bridging loans come handy in real-estate sectors are:
- In case you are purchasing a new property before you sell of your current owned property, however, you need to do a certain down payment to purchase the new one. In this scenario, you can avail bridging loan, which allows you to take equity out of your current home and use it as a down payment towards the purchase of new one. However, you must repay the same at the earliest possible to end up paying more because of high interest rate and administrative costs. In a general case, when you opt for bridging loans, be ready to expect interest rate as high as 1.5% per month i.e. 18% a year.
- It is also used by the real estate developers and builders to continue with the project while they work out the approval. Once the approval is sought, it becomes more eligible for getting approved for a conventional loan and in the meanwhile that is getting processed, the project or the construction work begins to ensure timely delivery of the same.
- It can also be used in case of a joint business venture, where one of the partners decides to part ways while the other decides to continue with the same.
- Bridging loans are also used in auction property purchases where the purchaser generally has only 14-28 days to complete long term lending such as buy-to-let mortgage may or may not be viable in that time frame whereas bridging loans would be.
2. Bridging loans in corporate finance: Bridging loans are also used in venture capital and other corporate finance for several purposes such as:
- To infuse small amounts of cash to ensure that the company operations are running successfully and it does not run out of cash at any point of time.
- As a final debt financing to carry the company through the immediate period before an initial public offering or an acquisition.
- To carry distressed companies while searching for an acquirer or a big investor.
Where Can You Get A Bridging Loan?
Best way to get a bridging loan is to get it through the Financial Conduct Authority (FCA). In case you are opting for a broker in order to get rid of paperwork etc, it is highly advisable to opt for an FCA-regulated broker because they are best aware of the rules and regulations of the Financial Conduct Authority and also they will be able to recommend a bridge loan as per your requirement and eligibility. Money supermarket, is a credit broker who will show you the options available with the lenders. The best part with the FCA regulated brokers is that they do not charge any fees from the customers and their fees are paid by the lenders instead.
What is the Interest on a Bridge Loan?
Bridging loans carry a higher interest rate as compared to a conventional loan and it typically comes with arrangement fees of 1 percent of the sum advanced, plus interest of about 1 percent a month. A bridge loan is typically good for a six month period, but it can extend up to 12 months. Most of the bridge loans carry an interest rate roughly 2% above the average fixed rate product and come with equally high closing costs.
Bridging Loan Interest Rates and Fees
There is various interest rate of bridging loans depending on the amount you are applying for. For example:
For loans over £2 million, interest rate is 0.35% per month, whereas for loans under £2 million, interest rate is 0.37% per month, whereas bridging loans with 55% loan to value, 65% loan to value and 75% loan to value, interest rate is 0.44% per month, 0.54% per month and 0.64% per month respectively.
Vast majority of bridging loans is on the following plans:
|Loan to Value (LTV)||Rate Per Month|
|Up to 40%||0.48%|
|40% to 50%||0.53%|
|50% to 65%||0.63%|
|65% to 75%||0.69%|
|70% to 75%||0.84%|
There are many costs which you need to consider while opting for a bridging loan and the first and most important point to consider is the interest rate, which is usually expressed as a monthly rate and when compared to other finance options, the interest rates of bridging loans will usually seem high and that’s why bridging loans should only be used as a short term funding options. Apart from the high interest rates, it is also important to consider all the other costs because they add up in no time.
So, the best way to compare all options and what a bridging loan is going to cost is to add up all the interest charges for the time duration you want to take the loan for and add this figure to all the other costs involved. Although the monthly interest on the bridging loan can be paid on the monthly basis, for most of the facilities you have an option to have an interest rolled up, retained or deferred, which also means no monthly fees need to be made and interest is only paid at the end of the term when the loan is redeemed. Apart from the monthly interest rate, there are other fees which are involved with the bridging loans such as:
A) Facility Fee (Lender’s Arrangement Fee):- Lender’s arrangement fee is charged by the lender it normally ranges from 0 to 2% of the total amount and it is included in the loan facility.
B) Exit Fee: - This is, in a way similar to the facility fees, however, it is charged and added to the loan when it is redeemed. Nearly all the bridging loans have exit fees.
C) Legal Fees: In addition to the facility fees, at times you might need to pay for the lender’s legal set up as well and legal fees can vary considerable depending on the lender.
D) Administration Fees: Administration fees involved with the bridging loans is quite high as compared to the conventional loans.
E) Valuation Fees: In order to set up a bridging loan, a valuation is required as well.
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