Finance · 17 April 2018

What is a bridging loan and how does it differ from traditional finance?

The most common use of bridging loans is for the purchase of property

You may be in need of some short-term finance to support a property purchase, in which case, have you ever thought about a bridging loan? Business Advice expert Rob Drury explains what this kind of loan is and how it might help your business move to new premises.

What is a bridging loan?

We are all aware of the typical loans that you might take out, either as an individual or as a business, where you borrow a certain amount of money for period of time, and pay this loan back in instalments over the lifetime of the loan, until the borrowed amount plus some level of interest is paid back.

It could be a payday loan of a few hundred pounds to tide you over until your salary hits your bank account, or it could be a loan of a few thousand pounds in order to purchase a new vehicle.

A bridging loan isn’t too different in its operation, as it is a loan over a short period of time, which helps you as you move forward with a purchase before you’re able secure more stable, permanent finance.  They effectively provide a “bridge” for you to go from one form of finance to another.

In what scenarios would you use a bridging loan?

The most common use of bridging loans is for the purchase of property, where there’s an opportunity to make a purchase, perhaps at auction or where there is a gap between the completion date on a new property and the sale date of your existing property.

More recently, some businesses have used them to overcome challenges where banks might take a considerable time to process applications for large loans.

In these scenarios, there is a gap between when the money is needed and when your alternative funds become available, and it’s the bridging loan that bridges this gap.

How do they work?

There are typically two types of bridging loans; open, and closed.

  1. Open loans

Open loans have a greater level of flexibility, as there is no fixed repayment date for the loan (although it will most likely be less than twelve months from when the loan is taken out). This type of loan is common when the sale on your old property is not yet known.

  1. Closed loans

Closed loans have fixed repayment dates and so are used when the sale of your property is known and you just need to get from one known date to another.

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Are bridging loans expensive than traditional loans?

The short answer is yes, through potentially higher interest rates or through administration fees, as the lender looks to make their profit in a shorter period of time to a traditional loan lender.

However, it’s not just cost that you need to be concerned about, as they also carry with them a considerable risk, as you are typically going ahead with the loan based on the future sale of something like a property.

If something derails that sale then you’ll need to have an alternative method of paying back the loan that doesn’t involve the funds from the sale that is no longer happening.  Your bridging loan provider would most likely want to see evidence of this plan B, in order to be reassured that they’re going to get their money back.

So why risk it?

Bridging loans can often be arranged very quickly, some times within twenty four hours, so they can be a great option if an opportunity arises that you need to take action on, such as a property coming up at auction when obtaining more traditional finance might take weeks to arrange.

They are designed for specific needs, not your every day finance, so you won’t be looking to use them very regularly, but you never know when you might need to respond to the market.

Take a look back at Rob’s recent Business Advice articles:

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ABOUT THE EXPERT

Former footballer and cinema manager Robert Drury has been a digital professional since 2000, specialising in project management, client services, and product management. He supported global brands such as Kraft Foods, Peugeot Citroen, and Lloyds Banking Group with their online presence before moving into startups. He was a founding team member at Ormsby Street, a small business financial information tool, before moving to Qudini to oversee the development of that firm's customer experience software product.

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