A bridge loan is a type of short-term loan, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing. It is usually called a bridging loan in the United Kingdom, also known as a “caveat loan,” and also known in some applications as a swing loan. In South African usage, the term bridging finance is more common, but is used in a more restricted sense than is common elsewhere.
A bridge loan is interim financing for an individual or business until permanent financing or the next stage of financing is obtained. Money from the new financing is generally used to “take out” (i.e. to pay back) the bridge loan, as well as other capitalization needs.
Bridge loans are typically more expensive than conventional financing, to compensate for the additional risk. Bridge loans typically have a higher interest rate, points (points are essentially fees, 1 point equals 1% of loan amount), and other costs that are amortized over a shorter period, and various fees and other “sweeteners” (such as equity participation by the lender in some loans). The lender also may require cross-collateralization and a lower loan-to-value ratio. On the other hand, they are typically arranged quickly with relatively little documentation.
Bridge loans are often used for commercial real estate purchases to quickly close on a property, retrieve real estate from foreclosure, or take advantage of a short-term opportunity in order to secure long-term financing. Bridge loans on a property are typically paid back when the property is sold, refinanced with a traditional lender, the borrower’s creditworthiness improves, the property is improved or completed, or there is a specific improvement or change that allows a permanent or subsequent round of mortgage financing to occur. The timing issue may arise from project phases with different cash needs and risk profiles as much as ability to secure funding.
A bridge loan is similar to and overlaps with a hard money loan. Both are non-standard loans obtained due to short-term or unusual circumstances. The difference is that hard money refers to the lending source, usually an individual, investment pool, or private company that is not a bank in the business of making high-risk, high-interest loans, whereas a bridge loan is a short-term loan that “bridges the gap” between longer-term loans.
For typical terms of up to 12 months, 2–4 points may be charged. Loan-to-value (LTV) ratios generally do not exceed 65% for commercial properties, or 80% for residential properties, based on appraised value.
A bridge loan may be closed, meaning it is available for a predetermined time frame, or open in that there is no fixed payoff date (although there may be a required payoff after a certain time).
A first charge bridging loan is generally available at a higher LTV than a second charge bridging loan due to the lower level of risk involved, many UK lenders will steer clear of second charge lending altogether.
Lower LTVs may also attract lower rates, again representing the lower level of underwriting risk, although front-end fees, lenders legal fees, and valuation payments may remain fixed.
- A bridge loan is often obtained by developers to carry a project while permit approval is sought. Because there is no guarantee the project will happen, the loan might be at a high interest rate and from a specialized lending source that will accept the risk. Once the project is fully entitled, it becomes eligible for loans from more conventional sources that are at lower-interest, for a longer term, and in a greater amount. A construction loan would then be obtained to take out the bridge loan and fund completion of the project.
- A consumer is purchasing a new residence and plans to make a down payment with the proceeds from the sale of a currently owned home. The currently owned home will not close until after the close of the new residence. A bridge loan allows the buyer to take equity out of the current home and use it as down payment on the new residence, with the expectation that the current home will close within a short time frame and the bridge loan will be repaid.
- A bridging loan can be used by a business to ensure continued smooth operation during a time when for example one senior partner wishes to leave whilst another wishes to continue the business. The bridging loan could be made based on the value of the company premises allowing funds to be raised via other sources for example a management buy in.
- A property may be offered at a discount if the purchaser can complete quickly with the discount offsetting the costs of the short term bridging loan used to complete. In auction property purchases where the purchaser has only 14–28 days to complete long term lending such as a buy to let mortgage may not be viable in that time frame whereas a bridging loan would be.
Bridge loans are used in venture capital and other corporate finance for several purposes:
- To inject small amounts of cash to carry a company so that it does not run out of cash between successive major private equity financings
- To carry distressed companies while searching for an acquirer or larger investor (in which case the lender often obtains a substantial equity position in connection with the loan)
- As a final debt financing to carry the company through the immediate period before an initial public offering or an acquisition.
In South African law immovable property is transferred via a system of registration in public registries known as Deeds Offices. Given the delays resulting from the transfer process, many participants in property transactions require access to funds which will otherwise only become available on the day that the transaction is registered in the relevant Deeds Office.
Bridging finance companies provide finance that creates a bridge between the participant’s immediate cash flow requirement and the eventual entitlement to funds on registration in the Deeds Office. Bridging finance is typically not provided by banks.
Various forms of bridging finance are available, depending on the participant in the property transaction that requires finance. Sellers of fixed property can bridge sales proceeds, estate agents bridge estate agents’ commission, and mortgagors bridge the proceeds of further or switch bonds. Bridging finance is also available to settle outstanding property taxes or municipal accounts or to pay transfer duties.
Short term finance similar to modern bridging loans was available in the UK as early as the 1960s, but usually only through high street banks and building societies to known customers. The bridging loan market remained small into the millennium, with a limited number of lenders.
Bridging loans became increasingly popular in the UK after the 2008–2009 global recession, with gross lending more than doubling from £0.8 billion in the year to March 2011 to £2.2 billion in the year to June 2014.[unreliable source?] This coincided with a marked decline in mainstream mortgage lending in the same period, as banks and building societies grew more reluctant to grant home loans.
The overall value of the residential loan amounts outstanding in Q1 2016 was £1,304.5billion, an increase of 1.0% compared with Q4 2015 and an increase of 3.4% over the past four quarters.
As the popularity of bridging loans increased, so too did the controversy around them. In 2011, the Financial Services Authority (FSA) warned homebuyers against using bridging loans as substitutes for ordinary mortgages, expressing fears that some mortgage brokers might be misrepresenting their suitability.
In the United Kingdom, bridging loans are used in both business and real estate. In the former, they are typically used to free equity in order to boost cash flow. In the latter, they are used by home-movers to ‘break’ property chains by providing a short-term source of finance when there is a delay between sale and completion dates, by buyers bidding on property at auction, and by landlords and property developers to secure renovation finance for quick sale or to refurbish a property that is considered uninhabitable prior to obtaining ordinary mortgage finance.
Bridging loans can be secured as a first or second charge against real property, including commercial real estate, buy-to-let property, dilapidated property and land or building plots. Loan terms typically run up to 18 months, with compound interest charged monthly; as such, they are often more expensive than other types of secured home loan.
Bridging loans are defined as either ‘opened’ or ‘closed’. A loan is closed if the borrower has a clear and credible repayment plan or exit strategy in place, such as the sale of the loan security or longer-term finance. Open bridging loans are riskier to both the borrower and creditor due to the greater likelihood of default.
Bridging loans secured by first charge against a property in which the borrower or a close family member will reside are considered regulated mortgage contracts, and are therefore regulated by the Financial Conduct Authority (FCA). Bridging loans sold to landlords and property developers are generally not regulated; however, if the occupant of the rental property against which the loan is secured is or will be a close family member of the borrower, FCA regulation will still apply.
An exception currently exists in the case of mixed-use properties, where the borrower or a close relative will occupy less than 40% of the property. In March 2016, however, the UK will be forced to bring its existing legislation in line with that of Europe, under the pan-European Mortgage Credit Directive (MCD). As the MCD does not recognise usage thresholds when defining a regulated contract, it is currently unclear whether the ‘40% rule’ will continue to apply.
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- ^ Jump up to:ab Bridging loans increase 45pc due to new landlord appetite The Telegraph. 21 October 2011. Retrieved 29 November 2018.
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- ^Private equity turns to early loans to boost returns Financial Times. 1 January 2018. Retrieved 29 November 2018.
- ^Badenhorst, PJ et al. Silberberg & Schoeman’s The Law of Property. Fourth Edition. Butterwoths. 2003
- ^Deeds Registries Act, 47 of 1937
- ^Brief history of the bridging finance sector Mortgage Finance Gazette. 4 August 2016. Retrieved 27 November 2018.
- ^ Jump up to:ab c Bridging loans guide. Money Supermarket. Accessed on 1 Jun 2015.
- ^“MLAR statistics”. www.fca.org. Retrieved 14 July 2016.
- ^Powley, T. Borrowers warned on bridging loans. Financial Times. 25 Nov 2011
- ^Haill, O. Types of bridging loan and how they compare to alternatives. FT Adviser. Apr 18 2013.
- ^“Archived Document”. Archived from the original on 2015-06-02. Retrieved 2015-06-01.
- ^Financial Conduct Authority Handbook PERG 4.4.1. Accessed on 1 Jun 2015.
- ^How will the Mortgage Credit Directive affect mixed-use properties? Economic Voice. 27 Mar 2015.
Ofer Abarbanel is a 25 year securities lending broker and expert who has advised many Israeli regulators, among them the Israel Tax Authority, with respect to stock loans, repurchase agreements and credit derivatives. Founder TBIL.co STATX Fund.