What Are The Risks Of Bridging Loan?

A bridge loan, also known as a bridging loan, is a good financing option for buying or investing in residential property. It offers numerous benefits, including speed of arrangement and flexible eligibility criteria. With the increasing popularity of bridging finance, p2p lending platforms also started offering such loans. However, you must remember that, like most financing options, there are pros and cons. 

Here in this article, we will describe what a bridging loan is, how it works and what risks it carries. 

What Is A Bridging Loan? 

A bridge loan is a short-term financing option used to bridge the gap between purchasing a new property and selling an existing property. In addition to being a useful tool for those looking to buy a new property quickly, these loans also carry several risks that should be carefully considered.

The term of a bridge loan can vary from 2 weeks to 3 years. However, most bridge loans are usually between 6 and 12 months in length. Most homeowners choose bridge loans to close a property deal, either as an investment or as a way to buy another property while they wait for their current one to sell.

How Does A Bridging Loan Work? 

Like traditional mortgages, bridging loans are secured types of loans. They are typically secured against your property, so you risk losing your property if you fail to repay the loan. The duration of a bridging loan is usually less than one year, and the interest payments and capital are normally all paid back in one lump sum at the end of the loan. 

Depending on the lender, you may be able to get a different amount.

There is usually a minimum loan amount of £25,000, but there are no fixed upper limits. The lenders set these and are often a percentage of the sale price.

The bridge loan works in the same way as a traditional mortgage, but you will need some equity in the property you intend to purchase to qualify. For example, if your home is worth £400,000 and you still owe £250,000, you have £150,000 in equity. The loan must be backed by collateral, so it's important to always be able to access it.

Risks Of Bridging Loans

Before making a final decision, it is essential to consider the risks of bridging finance. Here we are explaining these risks: 

High-Interest Rate

Bridge loans tend to have higher interest rates than traditional mortgages, which is one of their main risks. Because of this, they are regarded as higher-risk loans, as the borrower may not have the same level of financial stability as someone who would use a traditional mortgage to buy a property. As a result, the borrower may face higher monthly payments and overall costs.

Short Repayment Terms 

Another risk of bridging loans is that they often have a short repayment term, usually six to twelve months. Consequently, borrowers must have a solid repayment plan for the loan within this timeframe; otherwise, they may default or be penalized. In addition, if the borrower cannot sell their existing property within the repayment term, they may have to extend the loan or seek additional financing, which can result in additional costs and interest costs.

Property Repossession 

A bridging loan also has the risk that it is typically used by property investors or developers, which means it is secured against the purchased property. Unlike traditional mortgages, the lender can take possession if the property doesn't sell. Thus, the borrower is taking on more risk since they could lose their property if they cannot repay the loan.

Difficulty In Finding A Lender 

Additionally, the borrower may be unable to find a bridging loan lender willing to provide one. In order to determine the loan amount, the lender will look at the borrower's creditworthiness, the value of the property being purchased, and the value of the property being sold. The lender may not issue a loan to a borrower if they believe the borrower is likely to default. 

Last but not least, it's important to remember that the lender can foreclose on the property if a borrower defaults, which means that the borrower will lose the property and may face legal action. As a result, the borrower may also have trouble getting credit or loans.

Does Bridging Finance Affect Your Credit Score? 

Your credit score is affected by the number of recent applications, so if you applied unsuccessfully for a loan, it would appear on a subsequent credit check unless a period has passed.

Although bridging loan providers emphasize credit scores less than mortgage lenders, it is still possible to obtain a bridging loan even if you have credit issues.

Alternatives To Bridging Loan

You can get the money you need in a couple of ways that are less risky than bridging loans:

Get a mortgage on your second property - this will mean you have a longer loan term, but it might be less expensive in the long run.

It is possible to make small overpayments to the mortgage with the proceeds from the sale. Be careful not to overpay too much, or you may have to pay the penalty.

You can borrow up to £50,000 in an unsecured personal loan, which may be useful if you need to bridge a smaller gap.

Interest on personal loans is calculated annually, so your repayments might be less expensive.

If you can't make a payment on these loans, your new place isn't at risk.

Conclusion 

While bridging loans can be a useful tool for those looking to buy a new property quickly, they also come with risks that should be carefully considered before taking on this type of debt. Borrowers should be aware of the high-interest rates, short repayment terms, potential for property loss, and difficulty finding a lender. It is important to carefully weigh the potential benefits and risks of a bridging loan and to seek professional advice before making any decisions.