Use of bridging loans has grown substantially in recent years, although they remain a relatively small part of the UK mortgage market. One potential reason for this is that bridging loans are seen by borrowers as being riskier than regular mortgages. This is certainly partially true, as the short-term nature and higher interest rates on bridging loans does imply some higher risks. However, the two most important risks to understand in bridging loans are exit strategy risks and risks around terms and conditions.
Reducing risk in a bridging loan
The most essential part of reducing risk in a bridging loan is possession of a predetermined, high probability exit strategy. Failure of the strategy can lead to an uncomfortable and expensive situation. For example, if a homeowner is moving house, but the purchase of their new home must be completed several months prior to the sale of their current house, they may choose to use a bridging loan to allow them to buy their new home before having sold their existing one. However, should the sale fail to complete for any reason, the homeowner would be stuck paying two mortgages simultaneously for longer than they anticipated. The monthly payments on the bridging loan would also be higher than for a regular mortgage, due to the higher interest rate charged by the lender.
The borrower should also have a back-up strategy
To reduce risk, the borrower should assess, prior to accepting the bridging loan, whether they would be financially able to maintain this situation for longer than planned – such as if it took six months rather than three to sell their current house. The borrower should also have a back-up strategy in case this actually occurs. In this case that could be reducing the price of the current house to help it sell faster, liquidating other investments to raise cash, or seeking a tenant for the current property.
Bridging loans are sometimes poorly understood and can have an undeserved reputation for complexity. They can be easier to obtain than regular mortgage loans, if the borrower can meet a set of specific conditions. However, it is vital to understand that because bridging loans are extended against a set of specific circumstances, they typically come with quite restrictive terms and conditions.
The borrower sticks to their stated plan
It is important that the borrower sticks to their stated plan, as declared on the loan application, as the lender will use this intention, together with the borrower’s specific circumstances, to assess risk. For example, a bridging loan extended on the basis that it will he used to buy a property at auction and for the buyer to move in immediately, might have terms that explicitly prevent the buyer from conducting major property renovation during the term of the loan.
One potential way to mitigate some risk on a bridging loan is to roll up the interest payments to the end of the term. This will make the loan more expensive but will eliminate the risk of a default if the borrower is unable to keep up payments. Bridging finance can give homebuyers an essential lifeline where traditional mortgage finance is not available, but it does come with risks. A bridging loan broker will enable potential borrowers to understand the risks and help to choose a bridging loan that is appropriate for their situation and requirements.