A bridging loan is a familiar concept in the world of property sales but is one that causes a degree of confusion in the business world. Anyone who has been through an awkward house purchase where different parts of the chain do not quite match up knows what it is all about. It is a short-term loan that bridges the financial gap between the purchase of a new home and the sale of the old one.
In business, the general principle is no different. Bridging finance is not a long term financial tool, but is a short term solution to a specific problem, usually one related to property or real estate. It makes cash available to facilitate a purchase while you arrange for either cash to arrive or a longer-term credit solution to be implemented, which will allow you to pay it off.
Due to the speed of arranging bridging finance it is commonly used to purchase property at auctions, hence the term “auction finance”.
How does bridging finance differ from a regular loan?
The short-term nature of a bridging loan makes it quicker and easier to put in place. The main thing that the lender will want to see is that you have a tangible and demonstrable exit strategy in place. In other words, you need to show them how you are going to be able to repay it. But as long as you can provide satisfaction on that point, the loan is usually quick to arrange, taking as little as 7 days.
Typically lenders will lend up to 75% loan to value, although often they will use a conservative valuation figure. A legal charge will be taken over the property being financed.
What if the exit is unclear?
Not every investment project is set in stone, so there might be occasions where that exit strategy is less than clear. For example, suppose the loan is to finance property that will be renovated and then sold off. In this case, the borrower might be offered something called an open bridging loan, whereby the exit date is replaced by a maximum time period, at the end of which the loan must be repaid.
Bridging finance represents a short-term mechanism to raise significant funds quickly, so it will come as no surprise to know that interest rates are typically higher than with a conventional business loan. This is why it is important, despite the urgency, to shop around and ensure you are getting quotes from as wide a range of lenders as possible. Some lenders will allow you to defer the interest payment till the end of the loan, which can be a real bonus if money is tight during the financing period.
Using bridging finance for other purposes
We mentioned earlier that bridging finance is most commonly used for property transactions. However, this is not necessarily a rule that is set in stone. The lender is mostly interested in understanding the exit strategy, so as long as this is clear, the exact purpose to which the business will put the money is of secondary concern. If you need a short-term cash injection for some other business purpose, bridging finance could still be a solution. As ever, the best thing to do is get some independent and impartial advice on the different finance options that are available.