What is a Bridge Loan?
In This Article, We Are going to Know What is a Bridge Loan?
A bridging loan is a type of short term financing. It is used by individuals to complete the current obligations before they can secure a permanent loan. This type of funding is used to get immediate cash flow in urgent situations. Bridging loans have a high-interest rate compared to traditional investments, and they are backed by collateral such as property or business inventory.
These loans are available for individuals and businesses to fulfill immediate financial obligations. A bridge loan typically can be arranged in a short time period and with little documentation. For instance, if you want to buy a new property and sell an old one, you can take a bridge loan to buy the new property while you are selling the old one. In this case, your original property will become the collateral for the loan. Once you have arranged long-term finance, you can quickly pay back the bridge loan. Bridge loans are mainly used for real estate purposes, such as closing on a property or retrieving property from foreclosure. These loans are provided by several online platforms, including some well-known peer to peer lending platforms.
Types of Bridging Loans
There are four different types of bridge loans, including first charge bridging loan, the second charge bridging loan, open bridging loan, and closed bridging loan.
- First Charge Bridging Loan
A first charge bridge loan gives the lender a first charge over the borrower’s property. If a borrower defaults then the first change lender will get the money first before other lenders. This type of loan has a low-interest rate compared to the second charge bridge loan because of the low level of underwriting risk.
- Second Charge Bridging Loan
In this type of loan, the lender takes the second charge after the first charge lender. Second charge bridge loans are provided for a small period, generally less than 12 months. These loans have a high risk of default and hence have a high-interest rate. The lender starts recouping the payment the borrower only after every liability is accrued to the first charge lender has been paid. Also, the second charge bridging lender has the same repossession rights as the first charge lender.
- Closed Bridging Loan
Closed bridging loans are provided for a predetermined time period which has been agreed upon by both parties. It is accepted by lenders because it gives them great certainty about the loan repayment. It also has a low-interest rate compared to open bridging loans.
- Open Bridging Loan
An open bridging loan’s repayment method is undetermined at the initial inquiry, and you don’t get any fixed payoff date. In order to ensure the security of funds, the bridging loan providers take the loan interest from the loan advance. This type of loan is preferred by borrowers who are not sure when their finance will be available. Because of the loan repayment uncertainty, most lenders charge a high-interest rate for an open bridging loan.
How bridging loans Work?
A bridging loan is mainly used for real estate such as to make a down payment for a new property. If you are looking to buy a new house, then you have two options available.
- The first option is to add a contingency in the agreement of the house you are buying. The contingency will state the condition that you will only purchase the property after the sale of your old property is complete. However, this option might be rejected by some sellers if they have other potential buyers ready for immediate purchase.
- Your second option is to get a bridge loan for the down payment of your new house before the sale of your first house is complete. You can get a bridging loan and use your old property as collateral for the loan. You can then use the proceeds to pay off the loan and cover the down payment of the new house. Most lenders offer bridging loans worth almost 80% of the combined value of both houses.
Businesses can also get bridging loans to fund their working capital and cover cost as they wait for long-term finance. They can use these loans to cover different expenses such as payroll, utility, inventory costs, and rent. Distressed business owners can get bridge loans to ensure smooth running business while they search for the acquirer or large investors. The loan provider can take an equity position in the company to protect its interests in the business.
Since bridge loans are a short term finance solution, they are costly. They have high-interest rates, front-end charges, lender legal fees, and valuation payments. In addition, some providers insist take out a mortgage with them, which can limit your ability to compare mortgage rate across different companies. We Discussed What is a Bridge Loan in This Article