Bridging loans are an incredibly important financial tool. This type of finance is widely used throughout many different industries, and while it’s most commonly seen in property development and investment, bridging finance can be turned to many different purposes.
The key attraction of bridging loans is how flexible they can be. Unlike many other types of finance a bridging loan can be used by almost anyone, for almost any purpose. There are few restrictions, and the highly personal approach of many bridging lenders enables borrowers to secure the right finances for their needs.
One of the most useful niches for bridging loans is with 3rd charge loans. This non-standard type of lending relies heavily on the expertise of the lender and the strength of their client’s exit strategy. It’s a great example of what makes bridging so powerful, and why it’s such a useful tool in a wide variety of situations. In this article we’ll explore how 3rd charge bridging loans work, and why a borrower might seek out this type of finance.
In order to understand what makes third charge bridging loans an important financial option, we need to explore how charges work. When a lender provides money to help purchase an asset they’re taking out a “charge” against it. This means they have a stake in a percentage of the asset’s value. For example, if a business purchases a £300,000 office facility and borrows £150,000 from the bank, their bank has a charge against 50% of the property’s value.
In this example the business still owns 50% of their property, which is worth £150,000 - this is their equity. They may decide at a later date to free up some working capital. In order to do so they can take out a loan against this equity, essentially using it as security for the new loan. Let’s say they take out an additional £75,000 loan; because the property already has a charge against it, this new loan is a second charge. Because the business has used 75% of the property to secure loans, the property is described as having an encumbrance of 75%.
At its core, whether a loan is a first, second or third charge describes the order in which the lenders can collect their money. The first charge lender will recoup their money, followed by the second charge lender, leaving the third charge lender last in line.
This presents an element of risk for lenders who provide second and third charge loans. In the event that the property is repossessed and sold, they may end up losing out to the earlier lenders. Assets can only be secured for up to 100% of their sale value, which in theory means that every lender should make their money back.
However, if the property sells for less than its expected value this can easily lead to lenders further down the charge chain losing out. For instance, if our company from the first example goes out of business and their offices are repossessed, their bank (the first charge lender) will take over the sale of the property. The best offer they get is for £220,000; an £80,000 loss on the property’s value. However, as long as they make back their initial £150,000 loan, there’s no incentive for them to hold out for more.
For the first charge lender this doesn’t pose a problem - they’re making their money back easily. However, it only leaves another £70,000 in the pot to cover all subsequent charges. When the second charge lender comes to collect their £75,000 they’ll be £5,000 short; with no other assets to claim against, they have to accept the loss.
As we’ve just seen, there’s substantial risk associated with a third charge bridging loan. In order to help balance this, lenders who offer this form of finance are exceptionally diligent when assessing their clients requirements.
Above all, they’ll examine the borrower’s exit strategy. In most cases this will consist of either the sale or remortgage of the borrower’s property, in which case the lender will examine the likely value of their assets. Sometimes the borrower plans to take out a further loan as repayment, in which case their credit rating will be taken into account.
Because of the potential difficulties with recouping their loan, many bridging lenders will only consider providing third charge finance for experienced borrowers with a rock-solid exit strategy. Of course, the sheer flexibility of many bridging lenders means they can almost always meet the requirements of their clients, so it’s well worth exploring your options via a reliable mortgage broker.
Third charge loans can be exceptionally useful for releasing capital. Because they’re very often used on properties that are heavily encumbered already, they can be cheaper overall than extending an existing loan. Let’s go back to our example company; they’ve taken out loans against 75% of their property but they need more capital to fulfil a major order. They need another £60,000, which would bring their total encumbrance to 95%.
They could borrow more from their bank, but they would incur a higher interest rate by doing so. They’d pay this interest on a £210,000 loan, so their total costs would increase substantially. Instead, they seek out a separate third charge loan for £60,000. While the interest rate on this is much higher than on their first charge loan, it costs less overall because it’s on a smaller amount. In addition, many first charge lenders will charge an early termination fee if the loan terms are amended. Avoiding this is another reason why third charge bridging loans are so useful.
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