What is a Bridge Loan?
In simplest terms, a Bridge Loan is a type of gap financing arrangement wherein the borrower can get access to short-term loans for meeting short-term liquidity requirements. It is often used to meet current obligations, while permanent financing is being secured.
As is self-explanatory in the name itself, bridge loans are meant to “bridge the gap” until the borrower secures a mortgage or a long-term loan.
Such loans, which must necessarily be backed by some collateral – either real estate or business inventory – usually have relatively high interest rates and fees. Companies as well as individuals, who are in need for immediate cash flow, can access such loans.
How does a Bridge Loan work?
Buying Your Second Property
A very good example to explain the working of bridge loans is the case of buying a new property before the sale of your existing property.
So bridge loans are commonly used to finance the purchase of a new property while your current property is being sold, as well as provide finance to build a new home while you live in your current home.
Such loans are also used in real estate to prevent a property from foreclosure, or to buy a desired bargain property quickly. Though it is important to remember that in such cases, the original property becomes thecollateralfor the loan.
Also, when you use commercial property as collateral for one of these loans, it’s called a commercial bridge loan.
Sometimes bridge loans are used for buying multi-family or commercial properties, when the buyer needs funds to complete the sale of the property and then prepare/renovate it to seek a long-term loan with the property as a collateral.
In most cases, the lender will offer a bridge loan worth approximately 70 percent of the combined value of both the properties.
Solving immediate cash flow crisis in your company
Companies – whether small, medium or large – while waiting for long-term financing or an acquirer, also resort to bridge loans to finance working capital and cover expenses such as utility bills, payroll, rent, and inventory costs. Sometimes, lenders take an equity position in the company to protect their interests in the company.
What types of Bridge Loans are there?
Closed Bridge Loan
Favoured by lenders as it comes with greater certainty of loan repayment, a closed bridge loan is available for a predetermined time frame that has already been agreed on by both parties. That’s why such bridge loans have lower interest rates than an open bridging loan. However, the financial penalties for breaking the terms of a closed bridge loan can be far severe.
Open Bridge Loan
In contrast, open bridge loans are generally given with no fixed pay-off date, and as such, comes with higher interest rates. Also, sometimes the lenders, in a bid to ensure the security of their funds, deduct the loan interest from the loan advance. This type of bridge loans are preferred by borrowers who are uncertain about securing future finances.
As is self-evident, open bridge loans are less common than closed bridge loans.
What can bridge loans be used for?
As explained above, the most common, obvious, and very well-known use of bridge loan is in purchasing and increasing one’s real estate portfolio. Another use also mentioned above is to solve the immediate cash flow problems of a company and get hold of some working capital, till it secures long-term financing.
But there are various other uses of bridge loans as well.
Buying a property at auction
At auctions, the winning bidder typically pays a 10% deposit, which can be arranged easily through a bridge loan.
If you are in the business of renovating, converting or restoring properties
Securing a bridge loan against
Preventing property foreclosure
Another important use of a bridge loan is to pay off the loan and prevent a property from being repossessed so that the owner can retain control of the property, and sell it on their terms and avoid a forced sale situation.
Buying a bargain property (or any item for that matter quickly)
In ever-changing real estate markets these days, where buyers stand to gain much on capital
Usage of commercial bridge loans
A company can use a commercial bridge loan when changing office
Improving credit score
Sometimes, companies may opt for a bridge loan if their credit score needs improvement.
What is a First Charge Bridge Loan?
When a borrower takes out a first charge bridging loan with a property as a collateral, it gives the lender “a first charge” over that property.
This is just another way of saying that the lender has a lien on that property until the money borrowed is repaid. Simplistically, if there is a default, the first charge bridge loan lender will receive its money first before other lenders. This so, as in effect, the first charge bridge loan is supposed to be the primary loan that paid for the property, and is thus given priority over all other claims on the said property.
As the underwriting risks associated with first charge bridge loan is low, such loans attract lower interest rates. It is also common for lenders to insist upon certain restrictions – of further borrowing and property development which might lead to affecting the value of the property – for the duration of the loan.
Sometimes, a bridge loan lender take more than one property as collateral. This can be on a first or second charge basis, or a combination of both. For example, a bridge loan could be set up making use of a first charge on the property to be purchased. Then, the lender takes a second charge on another property [also owned by the same borrower] that already has a mortgage on it, but has some equity available.
What are the advantages of a Bridge Loan?
Advantages of bridge loans are aplenty as compared to other financing options, because they provide the cheapest option for securing immediate cash flow, are fast to arrange, have flexible lending criteria, and can be secured on any kind of real estate. While buying real estate, such loans help buyers by removing the contingency to sell first. So buyers can put their homes on the market, and wait out for a good deal, while buying without restrictions. Additionally, such loans typically don’t require repayments for the first few months, giving borrowers time to put their house in order.
Importantly, companies typically qualify for a bridge loan far easily than other long-term financing options. Moreover, bridge loan lenders often customize bridge loans to suit a variety of different needs for businesses, so often there are several options for companies to choose.
So the advantages of bridge loans can be summarised as follows:
Fast to arrange
As compared to traditional long-term financing measures, closed bridge loans can be arranged in as little as 48 hours.
Flexible lending criteria
Generally bridge loan lenders only look at the value of the collateral, and their exit route, while giving out the loans. They typically don’t worry about the traditional loan-giving benchmarks including income, affordability and credit history.
Any kind/type/state/standard of property can be the collateral
Freehold, cross lease, leasehold – both long and short,
Even properties in poor condition, derelict or in need of major restoration; as well as those with non-standard construction, are generally acceptable, which is not the case with a traditional mortgage provider.
Finally, it pays to also note few risks that are associated with bridging finance, which are all market dependent, especially when the bridge loan is taken to purchase a new house, putting the existing house as a collateral. These include – delay in selling the current house; keeping up with two loan repayments for such period of time; and when the current house finally sells, it does so at less than what you expected. This means you may end up with more debt than what you planned for.
So due diligence and engaging bridging finance experts is always advisable, when you think about taking out a bridge loan.
Read about when Rikvin Capital assisted a client in bridge financing used to purchase a commercial property in Glasgow here.
Need to apply for a bridge loan?
Rikvin Capital has specialists who can advise you on your loan needs and answer any queries that you might have.