Bridging loan

Bridging loan definition: How it works, pros and cons & more

What is a bridging loan?

A bridging loan is a form of financing to fill the gap between selling old property and purchasing a new one. It gives you a temporary short-term loan to cover the down payment or complete the purchase until the sale is finalised. Bridging loans typically have higher interest rates and are repaid once the sale is complete or alternative long-term financing is obtained to avoid high closing costs.

How does a bridge loan work?

Bridge loans work similarly to other loans but with a different process. Here, the loans are usually secured by the equity in the existing property and typically have higher interest rates and shorter repayment periods.

Once the sale is complete, repay the bridge loan with the earnings from your quick sale or secure long-term financing. Bridge financing is interim financing that allows you to get access to funds quickly, enabling you to make a down payment or complete a purchase before the sale of your current property is finalised.

Examples of a bridge loan

A few examples of situations where a bridge loan might be used:

  1. Home purchase - If you are buying a new home but haven't sold your current one yet, a bridge loan can provide temporary funds to cover the down payment or complete the purchase until your current home is sold.
  2. Property development - A bridge loan can provide the necessary capital if you are a property developer and need immediate funds for a new project while waiting for long-term financing or the sale of completed units.
  3. Property at auction - When participating in property auctions requiring immediate payment, a bridge loan can be used to secure the property quickly and later be repaid with funds obtained through a mortgage or the sale of another property.
  4. Renovations or repairs - If you want to renovate or repair a property before selling it, a bridge loan can be used for the costs of the renovations, and then the loan can be repaid once the property is sold.

These are just a few examples, and bridge loans can be used in various other scenarios where short-term financing is needed to bridge a financial gap.

Bridge loan vs traditional loan

Bridge loans and traditional loans are two separate types of loan and differ in several ways. Bridge loans are generally short-term loans used to bridge a financial gap, often for real estate transactions. With bridge loans, it is important to have an exit strategy as they have higher interest rates, shorter repayment times and are typically secured by collateral.

In contrast, traditional or conventional loans are long-term loans with lower interest rates and longer repayment periods, usually paid in small monthly payments. They are commonly used for home purchases, business financing or personal loans. Traditional mortgages often require a thorough credit check and detailed financial documentation, while bridge loans prioritise the value of the underlined property rather than your credit score or creditworthiness.

What are the pros of bridge loans?

Bridge loans offer several advantages:

  1. Quick access to funds - Bridge loans provide immediate financing, allowing borrowers to take advantage of time-sensitive opportunities.
  2. Flexibility - They can be used for various purposes, such as property purchases, renovations or bridging cash flow gaps in business.
  3. Easier approval - Bridge loans focus more on collateral value than your creditworthiness, making them accessible to people with bad credit.
  4. Convenient repayment - Repayment is often made once the existing property is sold or long-term financing is secured, offering a temporary financial solution without long-term commitments.

What are the cons of bridge loans?

Bridge loans also have some drawbacks to consider:

  1. Higher interest rates - Bridge loans usually come with higher interest rates compared to traditional loans, increasing the overall cost of borrowing.
  2. Shorter repayment periods - The shorter loan term can put pressure on you to sell your property quickly or secure long-term financing.
  3. Risk of carrying two mortgages - If the existing property doesn't sell promptly, you may need to manage two mortgage payments simultaneously, increasing the financial burden.
  4. Limited availability - Bridge loans may be offered by specialised lenders, limiting the number of options available and potentially leading to less favourable terms and improper exit plans and high exit fees.

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