How Do Bridging Loans Work?

Typically a bridging loan is a short term loan. Commercial bridging loans might be for a few months and in some cases a year or more.

A bridging loan is meant to get you from one point to another financially. It ‘bridges the gap’ between one source of finance and another. Often this type of loan is used whilst more permanent financing is approved or before a mortgage or similar finance can be considered for a venture.

The sums of money involved in a bridging loan can vary between £1,000 ($1546 USD) and £25,000 ($38655 USD) and will be secured against a property or a business. So you need to be sure you have a way of repaying this loan as the secured item is at risk otherwise.

When you take out a bridging loan, the lender will need to see that you have an ‘exit route’. This is a way of repaying the loan usually via the sale of a property or longer term finance i.e. a mortgage or an investor buy-in to your company.

Some bridging loans are available to those with a poor credit history. If this is the case, the interest rate will probably be much higher to cover the risk.

Who uses bridging loans?

Individuals often use this type of financing to cover the deposit shortfall while an existing property sells to secure the mortgage on the new property. It is also a favourite of developers who cannot secure longer term finance while the development proceeds and sometimes while they await permits.

There are many other occasions when businesses might find themselves in need of bridging loans. Sometimes it is to bridge the trading gap while a company looks for new investors. Or when a partner wishes to retire from the business, a bridging loan can carry the business over until a new partner buys in.

Developers in the buy-to-let and investment markets often use this type of short term loan while they make the necessary improvements to the property. The bridging loan will be paid off once the property can be considered by mortgage lenders or in some cases is sold.

Bridging loans are also used to buy land either for building or farming and also for buying property at auction. For the latter the money is needed up front before a mortgage can be secured.

Other possible users of bridging loans are for new business ventures and start up businesses.

How is a bridging loan different to other loans?

It is quicker and easier to arrange which is why this type of loan is often used as an interim plan. It is likely to cost more i.e. the interest rates are often, but not always, higher than an ordinary loan.

A word of warning: just as a bridging loan is faster to put in place so is repossession put into place much faster in the very worst case scenario. Like all short term loan plans making sure that you have the exit plan in place is of prime concern.

Rob Rudd enjoys sharing his financial research whenever possible and writes for several finance and investment websites. He lives in Hampshire, UK with his wife and 3 children.