Are bridging loans risky?
The simple answer is that when you secure a loan against your property, you are taking a risk. That is true whether you’re taking out a bridging loan, a buy to let mortgage or even a standard residential mortgage.
The risk associated with bridging finance is often amplified due to the fact that they’re a short-term loan, with most loans being arranged for 12 months or less. They’re also associated with unusual circumstances, such as financing property purchases for pensioners, buying property at auction or buying unmortgageable property.
This is in contrast to mortgages, which are a long-term commitment, where you often have 25 years to repay the loan. This gives borrowers more time to manage any issues and come up with alternative plans should their main one fail.
What are the main risks?
There are several key risks that you take when taking out bridging loans, below we cover some of the main ones.
Although bridging loan costs have reduced in recent years, the interest rates charged are still higher than those on mortgages.
The higher rates charged lead to higher monthly payments, which can be difficult to keep up. Should you fail to keep up the payments, you’ll find yourself at risk of your loan being put into default by the lender.
When your loan is defaulted by the lender, they will look to redeem their funds at the earliest opportunity. While you will have an element of protection if you’ve taken a regulated bridging loan, there is little protection for unregulated and commercial bridging loans.
Ultimately, unless your loan is repaid, a defaulted loan will end in repossession of the security property, additional costs and a heavy impact to your credit file.
Failure to repay the loan at the end of the term
The importance of an exit strategy can’t be understated, and should it fail, you will be unable to repay the loan. As such, it’s crucial that your exit strategy is watertight.
When you fail to repay your bridging loan, your account will be placed in default and the collections process will begin. This means the potential for defaults, CCJs, liquidation of the holding company (if your property is held in a company name) and repossession.
Breaching the lenders terms
You can run into trouble with your lender even if the monthly interest is all up to date.
Each loan comes with a detailed set of terms and conditions, which set out exactly what you’re allowed, and not allowed to do during the loan term.
A good example is where an applicant decides to use the loan to extend or refurbish a property, where this isn’t allowed by the lender.
How can I minimise the risks?
The key to minimising risk is to be totally prepared from the beginning. You must consider all options before taking the loan, once your loan is in place – it may already be too late.
The first, and most important factor is your exit strategy. This must be totally comfortable and if the numbers are tight, make sure you have a backup plan.
For example, you’re planning on refurbishing an investment property to add value, which will allow you to refinance. In this scenario, you must consider what you’ll do if the improvements made don’t add the desired value. What if the market dips and you’re unable to exit?
A strong alternative exit strategy here would be to sell for a small profit, or even at breakeven to exit the loan. This could be the difference between allowing you to move on to the next project, or destroying your credit file and making future borrowing very difficult.
Rolling your interest into the loan will mean you owe more at the end of the term, but also takes away the risk of missing payments.
Where the monthly interest is very high, careful consideration must be made before committing to them. Where there’s a risk of default, you should consider rolling up or deducting the interest, leaving you with no monthly payments to make.
What are the key considerations when taking out a bridging loan?
Ultimately, bridging loans are a vital tool for homeowners and property investors, and can lead to excellent outcomes that otherwise wouldn’t be possible.
That said, it’s important that you approach them with care to avoid any undue risks.
Seeking professional help from an experienced bridging loan broker is often advised for those who aren’t 100% comfortable with the bridging market.