A ‘bridge loan’ is a short-term loan taken out by a borrower against their property. They then use this to finance the purchase of a new property. It can also be called a swing loan, gap financing, or interim financing. A bridge loan is usually good for a six-month period. You can extend up to 12 months and sometimes even 24 months. The interest rate is roughly 2% above the average fixed rate product and can come with equally high closing costs.
When to use bridging finance
Most people will use a bridging loan to bridge the gap between selling a property and buying a property. Be careful when you take out a bridge loans there is no guarantee your existing home will sell in a timely manner pay attention to all the terms of the loan and watch out for prepayment penalties. With this in mind, it can be a useful tool when all other options have been exhausted.
How do they work?
A bridge loan can be structured so it completely pays off the existing loans on the current property, or as a second loan on top of the existing loans. In the first case, the bridge loan pays off all existing loans, and uses the excess as down payment for the new home. In the latter example, the bridge loan is opened as a second or third mortgage and is used solely as the down payment for the new property.
- A bridge loan can be used to pay off the loan(s) on your existing property
- So, you can buy a new property without selling your current one
- Or it can act as a second/third mortgage behind your existing loan
- To finance a new home purchase
Why are bridging loan rates typically higher?
One obvious downside to a bridge loan is the high associated interest rate relative to longer-term financing option. The loans are only intended to be kept for a short period. As noted, interest rates on bridge loans can be costly, typically a couple percentage points or higher above what you would receive on a traditional home loan. Like a standard mortgage, the interest rate can vary widely depending on all the attributes of the loan and the borrower.
Bridging loans do come with a risk factor
Many critics find bridge loans to be risky. The borrower essentially takes on a new loan with a higher interest rate. But there is no guarantee the old property will sell within the allotted life of the bridge loan. However, borrowers usually don’t need to pay interest in remaining months if their home is sold before the term of the bridge loan is complete. But watch out for prepayment penalties that hit you if you pay the loan off too early!
Could a bridging loan be the answer?
If you need to borrow money for a short period of time, then it can be useful for you. It could help you to bridge the gap if you wanted to buy a new home before selling your old one. These kinds of loans can also be used if you buy a property at auction. In these cases, you need the money immediately but may have not sold your current property yet.
The alternative here would be remortgaging your current home onto a buy-to-let mortgage and using the equity released to buy a new property.
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If you would like to know more about bridging finance, then give us a call on 08081 551 807. We can chat through your circumstances and see what the best course of action would be for you.