One of the most frequently asked questions concerning bridging finance is about the difference between a closed bridging loan and an open bridging loan. This article explains the difference between the two, and remember, further information and clarification can be gained by getting in touch with us at Ascot Mortgages.
What is a bridging loan?
Perhaps this is the first matter we should explain. A bridging loan is a convenient way to borrow money for short periods of time. Loans are usually for periods of a year or less. Unlike long-term loans such as a mortgage, a bridging loan is not paid back in monthly instalments, but as one lump sum. It is typically used to borrow funds while waiting for money that will arrive in the future.
Bridging loans are used by individuals as well as commercial organisations. The most common use for an individual bridging loan is in relation to a property transaction. If a person is buying a house, but has yet to complete the sale of their existing house, then a bridging loan can be used to secure the purchase of the new home whilst waiting for the existing one to sell.
Bridging loans can sometimes be organised in one or two days, although two weeks is a more typical timespan. This is why they are ideal for securing property bought at auction while waiting for standard mortgages, which take considerably longer to arrange.
A closed bridge loan is one where the lender knows how you will pay back the loan and at what date you can do this. This is known as the ‘exit strategy’. If you know that you can pay back the loan from the sale of a property and have a completion date for the sale, then a closed bridging loan will be suitable. Alternately, you may have some other means of paying back the loan. For example, you may be waiting for inheritance money to be released and have a firm date when the transaction will be completed.
To obtain a closed loan, you will need proof of how you will pay and commit to a fixed date when you will pay back the full loan.
Closed bridging loans generally offer lower interest rates compared to open bridging loans because, with a defined exit strategy, the lender knows that there is a low risk of the borrower being unable to pay back the loan.
An open bridging loan is available if you do not have a clear exit strategy, although you will obviously have to pay back the loan when it is due, so you do need to know how you will manage to repay the loan. You may be relying on a property sale to pay back the loan, but do not have yet have a buyer or a fixed date when the property sale will be completed.
Since lenders regard open bridging loans as more risky, they usually have a higher interest rate than closed loans, and the lender will need to be satisfied that you will be able to pay back the loan.
You will normally expected to pay back the loan within six or twelve months depending on the terms you choose at the start, otherwise you will be charged penalty fees. Of course, you can pay it back sooner, and some lenders allow you to pay some or all of the interest before you pay back the full amount of the loan.
Commercial open and closed loans
Business owners often use bridging loans to finance the expansion of their business. Some have seasonal sales and need a bridging loan to buy stock and meet their payroll. For example, some retail businesses do the bulk of their sales around the Christmas period and experience a slack period during the summer months. They may need a bridging loan in the summer to keep the business going until Christmas sales arrive. Obviously, this issue will be reversed for companies that peak in the summer.
Commercial borrowers, in the same way as individuals, can choose an open or closed loan. A typical case where a closed loan is required is when a business is moving premises. If they have both a completion date for the purchase of the new premises, as well as the completion date for the sale of their existing premises, then a closed bridging loan makes sense. If, on the other hand, the business does not yet have a buyer for their existing premises, then an open loan is more appropriate.
Another common commercial use of bridging loans is for property development where a series of bridging loans can be used to finance each stage of the project, with the money being repaid from the sale of the development.
Whether the loan is an open or closed bridging loan, a business or individual needs to have a clear idea on how and when they are able to repay it. Lenders charge commercial and individual borrowers penalties for loans that are not repaid on time. These can range from an extra 1% interest, to considerably more.
Should the client or their family member intend to live in the security address, any open and closed bridging loans related to it will be regulated by the Financial Conduct Authority, which means that they have to follow strict rules to protect borrowers from unfair practices. However, other bridging loans are not regulated.
Your first step
For individuals and commercial organisations who think that they need a closed or open bridging loan, the first step is to talk to the experts here at Ascot Mortgages.
Book a free consultation with us today. We can find the best bridging loan tailored to your requirements and give you a quote in minutes. However much you need, we can find the most competitive UK rates for your loan.