What is bridge financing & how it works – 4 min guide.

You will no doubt have come across the term bridge financing which can be used in many different scenarios. While sometimes seen as a “risky” transaction, the vast majority will be asset-backed and a simple short-term finance stopgap. The terms and conditions associated with any bridge financing will be directly related to assets and the level of security available. We will now take a look at the subject matter in more detail.

What is bridging finance?

As the name suggests, bridge financing, sometimes referred to as a bridging loan, is a means of bridging a finance gap when looking to purchase an asset. One of the important factors to note is that there are no monthly repayments and the loan is paid in its entirety plus interest at an agreed date in the future. One of the more common uses of bridge finance is when looking to acquire a new home. There may be slightly different settlement dates so a short-term loan until house sells ensures you don’t miss out on your dream home. However, before you even consider applying for bridging finance it is important to know exactly how it works, the cost, as well as the pros and cons.

How does bridging finance work?

There are numerous different ways in which bridging finance can be used in both personal property transactions and business. We will now take a look at a typical example to give you an idea:-

Moving home

In this example, we have a couple looking to move to a new home but they have not yet sold their current home. Using a short-term loan until house sells is a means by which they can secure the purchase of the next property before the sale of their current home. The process is fairly simple:-

Scenario:-

• A couple currently own a home valued at NZ$1 million
• The property has been paid off and there is no mortgage outstanding

The couple are looking to downsize to a new property valued at NZ$800,000 and they believe they can sell their existing home within three months. The problem is that they need to buy the new property now as other buyers are interested and it may not be on the market too much longer. Using bridging finance, the solution is fairly simple:-

• Bridging lenders would provide short-term finance to 80% of the value of the existing property
• The client buys the new property for NZ$800,000, with the potential negotiating benefits of a “cash buyer”
• Charging interest of 1% per month, the target would be repayment within three months
• The loan would be secured against the current property with immediate repayment on sale

The degree of headroom between the outstanding bridging finance and the value of the property to be sold gives a degree of comfort for bridging lenders. Unless the property market was to fall by more than 20%, there would be sufficient funds available to repay the short-term finance on the sale of the property. If we move the process further on, there are a number of different scenarios:-

Property sale goes through within three months

In this scenario, the property sale goes through within three months at the NZ$1 million asking price. Including interest, the amount due on the bridging finance is as follows:-

• Three times monthly interest charge of NZ$8,000 = NZ$24,000
• Initial funding plus interest = NZ$824,000

So, once the property is sold, NZ$824,000 is passed to the bridging lender with the couple receiving the balance of NZ$176,000.

Property takes a little longer to sell

Unfortunately, not everything goes to plan and it may take a little longer to complete the sale of the property. If we assume it takes six months for sale proceeds to be received, the outstanding finance would total:-

• Six times monthly interest charge of NZ$8,000 = NZ$48,000
• Initial funding plus interest = NZ$848,000

In this scenario, there would still be a balance of NZ$152,000 paid to the property owners on completion of the sale – at NZ$1m.

Failure to repay bridging finance

In a worst case scenario, let us assume that the property does not sell within six months and the bridging finance repayment date is missed. Bridging lenders would seek to negotiate with the borrower about additional security/repayments. In a worst-case scenario they could take control of the property and sell it at below the market price. An example of this situation would be as follows:-

• Six month repayment date is missed, no additional security or funds available
• Property is sold at 10% below the market price (for a quick sale) raising NZ$900,000

The NZ$900,000 would be sufficient to cover the outstanding finance and six months of interest, totalling NZ$848,000. In this situation, the homeowner would be left with a payment of NZ$52,000 although they would still own the second property.

Mortgage

In the above scenario, we have assumed the original home has been paid for in full and there are no outstanding debts against the property. Bridging finance still works if there is an element of equity and mortgage to repay. In this scenario, the lender would take security over the second property and the equity element in the first property. Consequently, the bridging finance would be repaid after the first property had been sold and the second property remortgaged. The loan to value ratio in this type of arrangement may vary because the owner’s financial situation could change and mortgage funding may be difficult to obtain.

When using any type of bridging finance, there needs to be a degree of security and significant headroom in the event that asset prices change.

Property refurbishment

If you’re looking to acquire a property which requires significant refurbishment, you may be able to use bridging finance to fund the work. Assuming that sufficient security was available, the perceived increase in the value of the property after refurbishment would be used as a basis to remortgage. The mortgage funds would then be used to repay the bridging finance and there may even be additional funds left over.

This is a common use of bridging finance for individuals and companies, an area in which we are particularly active. However, suitable security may be a little more challenging and other assets may be brought into the mix.

How much does bridging finance cost?

While the above examples perfectly illustrate the different ways in which bridging finance can be used, here at Alternate Finance we tend to provide funds up to a maximum of NZ$100,000. However, there is always a degree of flexibility where there is sufficient security available.

Our interest rate will depend on the security available, personal circumstances and how the funds will be used. Typically we provide relatively low interest rates of between 10% and 17.95% for our bridging finance services. This is significantly below our typical loan interest rate simply because of the element of security available and the relatively short timescale. Consequently, the rate of interest charged tends to be around 1% per month.

Traditionally, interest on bridging finance has been added to the outstanding loan and repaid at the end of the term. There may be occasions where we encourage clients to make interim payment to cover interest charges going forward. This ensures that the final repayment is more manageable especially in scenarios where the initial bridging finance duration is extended. As ever, these are terms and conditions which can be negotiated directly with clients.

Pros and cons of bridging finance

It is important to be aware of any pros and cons regarding bridging finance and the potential implications of default.

Pros of bridging finance

• Security should always cover any outstanding amount
• Short-term finance can help to bridge the gap between sale proceeds and reinvestment
• Loans can be arranged relatively quickly
• Traditionally there are no monthly repayments
• Security can help those with difficult credit histories obtain finance

Cons of bridging finance

• Relatively expensive interest rate compared to traditional loans (normally)
• Potential additional expenses if repayment dates missed
• In the event of default, security may be sold at below the market price to repay finance

Bridging finance vs Traditional loan

When comparing bridging finance and traditional loans, this is akin to comparing apples and pears. Typically, they are used in very different financial scenarios and there are some stark differences.

• Bridging finance applications tend to be relatively time sensitive with quick approval and processing
• Typically there are no monthly repayments with bridging finance, with interest and capital repaid at the end of the arrangement
• Cash flow is retained as funds from the sale of an asset are used to repay bridging finance
• With bridging finance there is less focus on an individual’s financial situation, more focus on security
• Traditional loans tend to be longer in duration and accumulate more interest
• Not all personal loans require security although an inability to provide security may result in relatively high interest charges

The subject of interest rates on traditional loans and bridging finance for those with a difficult credit history is worth discussing. Here at Alternate Finance, we provide personal loans with rates of between 13.95% and 26.98%, depending on circumstances. However, due to the relatively short-term nature of bridging finance and the level of security afforded, we offer rates of between 10.95% and 17.95% on this type of finance.

Summary

There is intense competition between bridging lenders, although we provide finance to those often positioned between traditional lenders and payday operators. Typical clients will use this type of short-term finance as a short-term loan until house sells, allowing them to buy their dream property before selling their existing home. When you see annual bridging finance interest rates quoted, it is important to note that many of these arrangements will last no longer than three months to six months. However, there may be scope to extend this in certain circumstances subject to the level of security available.

If you have any questions or queries, please feel free to contact us and we can review your situation in more detail. Here at Alternate Finance, we appreciate that time is very often of the essence with regards to bridging finance and we look to provide a quick decision on your application. Once approved, the paperwork will be processed as quickly as possible and funds typically in your account within 24 hours.