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September 14, 2014

A Guide to Bridging Finance Part. 2

In our Guide to Bridging Finance Part. 1 we shared with you a definition for Bridging and discussed the reasons why a borrower may require a real estate bridging loan. In part 2 we’re looking at the different types of bridging loans available, including;

‘Closed bridge’

Refers to a bridging loan where there is a predefined and certain exit that the borrower has in place to repay the bridging loan, before the actual bridging loan is taken out by the borrower.
An example of a closed bridge, would be where the borrower has an offer of finance from a mainstream lender prior to obtaining the bridging finance. In such instances the borrower may still need the bridging loan in order to settle a transaction quickly or otherwise capitalise on a particular opportunity.
A closed bridge is often used to settle a property purchased at auction. In this situation the borrower may already have an offer of finance from a banking institution that the borrower has a relationship with. However the relevant bank may be unable to complete their internal bureaucratic processes and legal documentation in time for the borrower to settle the purchase. Therefore the borrower can use a bridging loan to settle the property transaction (usually required within 30 days of the auction), and avoid any penalties that may be incurred if the transaction is not settled on the settlement date. In many instances, the borrower also risks losing their deposit if the transaction is not completed on time.
Another common example of where a closed bridging loan is used, is where the borrower is selling the property that the loan is secured against. In such circumstances the borrower may already have a contract for the sale signed and exchanged with the buyer, but the borrower wants to draw down on the equity in the property prior to the sale completing.

‘Open bridge’

Refers to a bridging loan whether the borrower does not have a certain exit in place. Bridging finance lenders will usually require the borrower to have a detailed ‘exit strategy’ for repaying the loan. However, with an open bridging loan, the exit strategy is not certain.
An example of an open bridge, would be where the borrower is required to settle a transaction in a very short period of time, and has not had a chance to arrange mainstream funding for the refinance. In such instances the borrower may have a long-standing relationship with a bank that is very likely to advance the loan, but an application for such finance has not yet been submitted to the bank.
During the ‘credit crisis’ the distinction between a closed bridge and an open bridge loan has been significantly blurred. This is because the certainty in which mainstream bank lenders are providing finance is often uncertain – even in situations where a borrower is particularly credit-worthy, or the asset involved presents a very solid lending case. As a result, a loan which may appear to be a closed bridge, but in fact it is in reality an open bridge loan.
The costs involved with obtaining a bridging loan will often depend on the borrower’s circumstances.
In the UK, typically interest rates will typically be around 1.5% per month. Some bridging companies will offer interest rates less than this, but these loans usually end up being as cumbersome and time-consuming as a bank loan, and will often have similar documentation requirements and Loan to Valuation constraints.
In addition to the interest rate, the borrower will usually be required to pay:

  • An Establishment Fee of between 1-2%;
  • The costs to obtain an independent valuation on the security property; and
  • The legal fees to prepare the loan documentation.

Most bridging financiers will allow for the costs associated with the loan, including the interest for the term of the loan, to be deducted from the loan advance. This means that the bridging lender will effectively ‘roll up’ these costs as part of the loan so that the borrower is not actually required to pay these costs until the loan is repaid.
To learn about the other terms often using in relation to Bridging Finance, such as First charge, Second charge and Mezzanine finance, read our Guide to Bridging Finance Part. 3.