Making the right financial decisions for your situation can be tricky if you don’t fully understand the terms being used. While it’s always a good idea to get some expert advice from a financial advisor before making a significant change or investment, you should aim to have at least a basic understanding of the financial terms you’re discussing so that you can make an informed decision.
What is bridging finance?
Bridging loans, collectively known as bridging finance, are a type of loan that allows you to borrow large amounts of money for short periods of time. The name comes from the idea of what they’re designed to be used for – to ‘bridge the gap’ in financial terms.
As such, they’re commonly used to make it possible to buy something while you’re still waiting for funds to come through from elsewhere. For example, if you’re a property developer, you might want to buy a house at auction to flip for profit. Bridging finance allows you to do this so you can renovate the house and sell it on, using the proceeds from the sale to pay back the loan.
Depending on your circumstances, there are two types of bridging loan that might be useful. These are:
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- Open bridging loans – these have no fixed repayment date, so they’re useful if you don’t know when your funds will be available.
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- Closed bridging loans – these have a fixed repayment date, so they can be more appropriate if you know when you’ll be able to repay. Since they’re less flexible, closed bridging loans typically cost you less in interest.
Whatever the case, any lender will need to see a plan for how you intend to repay the funds before they grant you a bridging loan. This is known as an exit plan or exit strategy. In the earlier example of the property developer, the exit plan is that the proceeds of selling the renovated property will cover the repayment of the loan.
A bridging loan is a ‘secured’ loan, which means that you must offer up something to the lender as security in case you can’t repay. Our property developer, for example, could secure the loan they need to buy a house at auction on that same house – so if they fail to make the necessary repayments, the lender can seize the house as recompense.
As we’ve mentioned, the cost of a bridging loan can depend in part on the type of loan you choose – the more flexibility you have, the higher the interest rate is likely to be. But it’s also the case that the assets you use for security can affect interest rates.
If you use a property you don’t have a mortgage for as security – for example, a property you own outright – then the bridging loan will be classed as ‘first charge’. If you default on the loan, the security will go straight to the bridging loan lender, who will sell it on to get their money back.
On the other hand, you might use a property that you do have a mortgage on. This would be known as a ‘second charge’ bridging loan. In this situation, if you fail to pay back the loan, then the mortgage lender would receive the property first. Any remaining funds after they’ve had their share would then be passed on to the bridging loan lender – though there’s no guarantee that there would be any.
Since second charge bridging loans are more risky for the lender, the interest rates on these loans tend to be higher. That means you might end up paying more interest on your loan than you would with a first charge loan, even if you borrow the same amount of money.
What’s the difference between regulated and unregulated bridging finance?
When you’re using a bridging loan to buy a property, it can be described as either regulated or unregulated, depending on your circumstances. This has an impact on the rules and regulations that govern your loan and its lender.
A regulated bridging loan is one in which you’re borrowing money to use for a property you either currently or will live in. For example, if you’re in a selling chain, you might use a regulated bridging loan to buy a new home while waiting for the old one to sell. These loans are regulated by the Financial Conduct Authority (FCA) and offer many of the same protections as a residential mortgage.
On the other hand, an unregulated loan is for when you don’t live in the property you’re getting the loan for. This applies to property developers, landlords and intermediaries, among others.
As the name suggests, regulated bridging loans involve more checks and processes that allow for greater control, meaning you may be better protected if something unexpected happens. However, this also means it can take longer to access the funds you need – so if you need money fast, a regulated bridging loan might not be the best solution.
While unregulated bridging loans don’t offer the same level of protection, they are much quicker to access, offering more financial flexibility. There are benefits and drawbacks to both kinds of bridging loan, and the right choice for you will depend on a range of factors. A financial adviser can help you to understand what you need so you can make an informed decision to better your finances.
