In the UK, it's common to search for a new home long before completing the sale of your property. In most cases, the sale and purchase involved in moving property take place concurrently. However in some cases it may be difficult to find a buyer in time to purchase the property you have your eye on. In situations like this, a bridging loan could help you to bridge the financial gap between the two transactions.
What is a bridging loan?
A bridging loan is a type of loan used to make a large payment before you have the capital to fund it. Most commonly this occurs when you're awaiting the sale of a property, but need to make a large down payment, for example to purchase a new property, or to pay for divorce settlements.
Many property developers also use bridging loans to secure property at short notice, such as at auction.
Bridging loans are a type of secured loan. This means you'll only be able to get one if you can guarantee something of a higher value than the loan itself, for example your house.
You may be offered better terms on a bridging loan if it is considered a first-charge loan. This means that there is no other loan taken out against your property that trumps the bridging loan. So for example, if you have paid off a mortgage, you're likely to be offered a better deal on a bridging loan than someone who's mortgage is relatively young. This is because, in the event of missing repayments, the lender would be able to reclaim a larger amount of the debt in a first-charge scenario.
How does a bridging loan work?
Bridging loans are generally short term, rarely more than a year. Because they're available at short notice, and can be used for large purchases, interest rates are generally high. When you factor in the high interest and the fact the loan is secured, bridging loans can be considered relatively risky. However for the purposes of making an important purchase quickly they can also be extremely useful.
What are the main types of bridging loan?
There are two types of bridging loan:
Closed bridging loan
A closed bridging loan is borrowed for a specified time frame, with the source of funds to pay off the loan, also known as an ‘exit plan’, clearly defined. These bridging loans are usually short term, over a few weeks or months.
Open bridging loans
The more flexible option, open bridging loans allow the amount to be paid back over a longer time frame, usually up to a year or sometimes two. For this reason the exit plan is less important, but interest rates are higher to account for a greater level of risk to the lender.
Like mortgages, bridging loans are available in both fixed rate and variable options. A fixed rate loan will have a set interest rate, so monthly payments will be the same throughout the duration of the loan.
Variable loans have an interest rate that follows economic trends. Usually this is the Bank of England base rate, which can change as often as every six weeks. As bridging loans are fairly short, variable interest should be less damaging than in a long term loan agreement like a mortgage.
Alternatives to bridging loans
If you're thinking about taking out a bridging loan, it's a good idea to compare loans of different types as well, in case another loan type might suit you better. Some alternatives include:
Personal loans are likely to be cheaper, with lower interest rates than bridging loans. However they usually offer significantly lower total loan amounts. Consider a personal loan if the purchase you need to make is not as significant as a property or vehicle.
Similarly to personal loans, an arranged overdraft can offer much lower interest rates than a bridging loan. Just like personal loans though, overdrafts usually have an upper limit. For more information, check out our guide on loans vs overdrafts.
Remortgaging works in a similar way to bridging loans, freeing up some capital for a purchase. The difference is that remortgaging consists of a long term loan, as opposed to a short term agreement.
Peer-to-peer borrowing is increasing in popularity, and could help in small to medium loan requirements. Larger borrowing is fairly uncommon though.