In addition to ordinary financing, there are other types of financing in the banking and financial sector. These include, for example, interim financing or pre-financing. Pre-financing should not be confused with pre-settlement funding, as both have completely different meanings.
As the name suggests, the main task of pre-financing is to bridge a period that takes place before the actual financing.
What is pre-financing?
Pre-financing is realized through a short-term loan, which is therefore often referred to as a pre-financing loan. This advance is usually used before a construction project starts until permanent financing is secured. Pre-financing should not be confused with the usual real estate loan.
Pre-financing can only be used for a period of one to two years because it is paid in advance of submission of the work ahead, while ordinary real estate loans usually have terms of ten to thirty years.
However, the essential feature of pre-financing is to bridge the period until the actual final financing is agreed upon.
Bridging mostly until the allocation of the home savings contract.
The final financing, until the end of which the pre-financing bridges the period, is usually a home savings contract, which is then ready for allocation or has yet to be allocated. Here is an example, suppose you have bought a house and therefore need a loan on it. This could look like this:
- The purchase price plus additional costs: $250,000
- Equity: $50,000
- Annuity loan: $120,000
- Building savings contract (building savings sum): $80,000, allocation in 1.5 years
In this scenario, you need $250,000, of which $170,000 are already available in the form of $50,000 of equity and $120,000 as an annuity loan. In addition, there is still a home savings contract with a home savings sum of $80,000 (home savings credit + home savings loan), which will only be allocated in around 1.5 years. Therefore you have to bridge this period, namely in the form of pre-financing.
A particular risk of pre-financing.
The bank that agrees to pre-finance takes on a higher risk than with the later final financing. The reason for this is that the follow-up or final funding that will be used to repay the pre-financing loan has not yet been determined. This not only refers to the point in time but possibly even to whether the final financing will come about at all. Therefore, pre-financing in the area of construction financing is also a lot more expensive than the final loan because the bank can, of course, pay for the higher risk.
Types of pre-financing.
Pre-financing is used in various areas; the example given to fund a home savings contract is just one of many. First of all, there are two different variants with regard to repayment modalities. A pre-financing loan is often repaid by disbursing the loan that is granted as part of the final financing.
Alternatively, the borrower may expect capital, such as a life insurance policy payment, which will then be used to repay the pre-financing loan.
Pre-financing, which is often also referred to as bridge financing, is used more frequently, also in the commercial sector, for example, in the case of planned company purchases.
But also, in general, for example, long-term investment loans are often pre-financed by loans with a significantly shorter term or no term at all, such as overdrafts.
Intermediate and pre-financing are often confused with each other since, in both cases, a period of time is bridged until final financing. The main difference between the two financing options is that with interim financing, the final later funding is already secured, so the lender’s risk is also lower.
In the case of pre-financing, on the other hand, it is not necessarily certain when and how the final financing will take place. In addition, bridging loans often have a shorter term