What is Bridging Finance?
The term ‘bridging finance’ refers to a type of short-term loan that’s used to ‘bridge’ the gap between a borrower’s debt and their existing stream of capital.
Bridging loans are sometimes classed by the Financial Conduct Authority as a ‘mortgage product.’ This is because bridging finance is often used to bridge the gap between the purchase of a residential property and the release of mortgage capital. The FCA only see bridging finance as a regulated product (or product that should be introduced/arranged/advised by a qualified individual/firm with the correct permissions) if the loan is made to a private individual when their primary residence is used as collateral for the loan.
Why use bridging finance?
Bridging finance has become an increasingly popular lending option since banks tightened affordability requirements for mainstream loan vehicles after the economic crash. There are several advantages to using bridging finance:
- Secured financing for assets: This type of funding vehicle allows investors to use cash tied up in existing assets such as property, stock, bonds etc. to facilitate the release of capital. This is because bridging loans are secured against the borrowers existing assets.
- Quick access to capital: Bridging finance comes with minimal red tape. This allows an investor to access capital where immediate action is necessary. For example, a bridging loan can be used to plug a gap in mortgage repayments to prevent repossession.
- Short-term funding: A large range of existing loan-based funding options are designed to be paid back over a number of years. This can prove costly because the loan accrues a significant amount of interest for the borrower to repay. However, bridging loans are designed to be repaid within a short space of time, which means that they can be used by investors to access capital without incurring heavy long-term repayment obligations.
- No affordability criteria: The reason that bridging loans have become popular is because the borrower doesn’t have to meet affordability criteria to secure access to capital. For instance, the funding vehicle has become particularly popular with pension-age borrowers who typically fail to meet affordability tests for mainstream loan options because banks see them as a risk due to their age.
- Venture funding: The nature of bridging loans means that they can be used to fund a venture without incurring significant costs. This allows the investor to maximise returns.
The risks of bridging finance
A bridging loan is a financial product, and like all financial products it comes with its own set of risks. Bridging finance often comes with higher costs e.g. rates of interest, than mainstream loan options. This means they can sap revenue from investors who don’t have access to capital to meet repayment obligations.
Seek independent financial advice
Bridging finance is a useful funding vehicle that can provide investors with quick, short-term capital that they can use to enter lucrative areas of the UK property market such as buy-to-let. However they aren’t right for everyone. The appropriateness of a bridging loan depends on the investors circumstances.
This is why I would advise investors to utilise the services of an Independent Financial Adviser (IFA) before taking out a bridging loan. An IFA will weigh appetite for risk against expectations concerning yield to determine whether bridging finance is an appropriate funding option for the investor.