Bridging finance: Our guide to closing the gap
What to look out for
- Red Commercial bridging finance is often more expensive than other types of finance, with high rates of interest
- Amber Retail businesses with highly seasonal sales can also use bridging finance to keep the business running when revenue is low
- Green Provide additional working capital to speed up the transition into profitability
Bridging finance is a short-term option to help both the start-up and established business bridge the gap between debt and payment.
Why would you use bridging finance?
Bridging finance is a short-term finance option to provide businesses or individuals with a sum of money for a short period. As the name suggests, it is intended to ‘bridge’ the gap between a debt or payment that is due to be paid and the funds to cover it becoming available.
It is often used when purchasing property. Home loan bridging finance is used if there is a gap between completing a purchase and selling a property to fund it – this is particularly useful if you’re in a chain or planning to buy a property quickly.
With mortgage applications taking several months, a bridging loan to buy property is useful if the finance is needed in a hurry – for example if you’re buying property at an auction. Bridging finance can also help with the funding of renovation or conversion work.
Other uses of commercial bridging loans are to provide additional working capital if a company’s management believes the business can achieve profitability in a year, but only has capital to cover operating costs for a shorter period.
Retail businesses with highly seasonal sales can also use bridging finance to keep the business running when revenue is low, with income from peak periods used to settle the loan.
Alternatively, a business looking to refinance to longer-term debt to improve its financial position could use bridging finance to make the transition.
How does bridging finance work?
There are two types of bridging finance: Closed and open. Closed bridging finance means the lender knows the borrower’s exit strategy – meaning the source of finance to pay off the loan and the date it will be paid.
Open bridging finance is offered with no known exit strategy. Obviously, the loan needs to be paid back, but the date when the funds become available does not have to be fixed. It is less secure for the lender, meaning higher interest rates apply.
Bridging funding is usually offered from one to 18 months with the loan repayable in full (including interest) at the end of the term. As there are no monthly repayments, it’s a good approach to raise capital if cash flow is tight.
Tightened bank lending following the financial crash of 2008 has seen the growth of specialised bridging loan companies.
When looking at who offers bridging loans, you can choose from small lenders with a handful of employees to larger professional businesses regulated by the Financial Conduct Authority. Going with one of the regulated lenders is advisable, as they will only recommend a bridging loan if it’s appropriate to your company’s needs.
What are the costs of bridging finance?
Commercial bridging finance is often more expensive than other types of finance, with high rates of interest. Interest could be 1.5 per cent a month, equalling 18 per cent per year. However, the interest rates currently offered are relatively low as a result of a competitive market.
There are often significant administration fees on top of the interest. You must consider these costs when calculating how much is a bridging loan going to cost.
A potential drawback of bridging finance is that if there is a problem with your repayment method, there can be major issues. Failure to repay at the end of the term is likely to result in financial penalties (upwards of one per cent of the total loan value) and could also see your account placed in default, negatively impacting your credit rating. It could even lead to repossession of property.
A non-financial cost of a bridging loan is that there is no guarantee that you would be accepted for a mortgage with a mainstream lender after using a bridging loan. It’s therefore advisable to consider your options carefully before committing to any form of bridging funding.
How long does it take to secure bridging finance?
Due to the way they are structured, bridging loans are often quicker to arrange than other types of borrowing. The application process is usually completed in five to 15 days.
What type of security do I need for bridging finance?
As it is often used to cover property costs, bridging finance is often offered against property or land. However, as long as there is a valid repayment strategy, other forms of security may be considered, depending on the lender.