What Are The Risks of a Bridging Loan?
Funding from £75,000 up to £25 million
Industry expert Mark Thomas discusses what are the risks of a bridging loan?
What Are The Risks of a Bridging Loan?
One of the main risks is the high cost associated with bridging loans. They tend to have much higher interest rates than standard mortgages, usually ranging between 0.5% and 1.5% per month, which equates to an annual percentage rate of 6% to 18% or more. In addition to interest, there are often several fees, such as arrangement fees, valuation fees, legal costs, and sometimes exit fees. If the repayment takes longer than planned, the accumulating interest can quickly make the loan very expensive.
Because bridging loans are secured against property, there is also a serious risk of repossession. If you cannot repay the bridging loan on time, the lender has the right to take possession of the property and sell it to recover their money. This is particularly dangerous if you are relying on the sale of a property to repay the loan and that sale falls through or is delayed.
Another challenge is the short repayment timeframe. Most bridging loans run for a period of three to twelve months, and sometimes up to eighteen months. If your exit strategy, such as selling a property or refinancing with a standard mortgage takes longer than expected, you could face heavy penalties, need to arrange a costly extension, or even be forced to sell your property at a reduced price to meet the deadline.
Types of UK bridging loan clients:
Homeowners
Commercial & Residential Landlords
Buy to Let Investors
Business Owners
Property Developers
Company CEO’s
What Are The Risks of a Bridging Loan?
There are five main risks associated with bridging loans:
- Your original exit plan doesn’t work out
- Interest payment arrears
- Default interest
- The loan is called in
- Unrealistic property evaluation
Are bridging loans risky?
In most cases no. As with any form of borrowing, there are certain risks involved, the main one being the inability to repay at the end of the term, causing debts to spiral.
Both lenders and brokers tend to carry a full assessment upfront to ensure any danger of non-repayment is minimal.
There is also a market risk to consider. If property prices fall during the term of the loan, the value of the property used as security could end up being less than the amount borrowed, creating negative equity. This situation could make refinancing more difficult and might lead the lender to demand additional collateral or repayment sooner than expected.
Your bridging loan will only work smoothly if you have a reliable exit strategy, but this can easily fail if circumstances change. For example, if you plan to repay the loan through a mortgage, rising interest rates or stricter lending criteria could prevent you from securing the mortgage, leaving you unable to pay off the bridging loan.
Even if you plan to refinance later, fluctuations in interest rates pose another risk. If mortgage rates rise significantly before you refinance, your future monthly payments could become unaffordable, or you might not qualify for the amount you need, blocking your exit route.
Some bridging loans also come with early repayment penalties, meaning that if you manage to repay sooner than planned, you could still face extra charges, reducing any potential savings.
Another issue is the effect on cash flow. Some bridging loans require monthly interest payments, while others allow the interest to be rolled up and paid at the end. If you choose a product where payments are due monthly, any changes to your income or expenses could put you under financial strain and increase the risk of missing payments.
Finally, there is a regulation factor to be aware of. Not all bridging loans are regulated by the Financial Conduct Authority (FCA). Regulated bridging loans are typically used for residential properties and offer more borrower protection. Unregulated loans, often used for investment properties or business purposes, provide fewer protections, meaning that disputes can be harder to resolve and terms may be less favorable.
To reduce these risks, it is important to have a clear and realistic exit plan, ideally with a backup option, and to work with a regulated lender whenever possible. Always compare different lenders to find the best rates and terms, and seek independent financial or legal advice before committing. Make sure to understand the total cost of the loan, including all fees and potential penalties, and consider taking a term slightly longer than you think you will need to allow for unexpected delays.
In summary, while bridging loans can provide a quick and flexible solution to short-term financing needs, they come with risks such as high costs, the potential loss of property through repossession, reliance on uncertain exit strategies, market fluctuations, and possible regulatory gaps. Careful planning and professional guidance are essential to avoid falling into financial difficulty.