Bridging Loans and Finance
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Feb 10, 2021
What is a bridging loan?
A bridging loan or bridging finance is a type of short term property backed finance that can be useful if you need to borrow money for a short period of time. Bridging loans are usually offered for 1-18 months, with the loan repayable in full at the end of the term. It can help to ‘bridge the gap’ if you want to buy a new home before selling your old one.
Bridging loans are a quick method to raise finance, for example you require funding to buy a property at auction, and your funds may be stuck in a property waiting to be sold. In this blog, we will aim to explain how bridging loans work and what are the pros and cons.
Why use a bridging loan?
Due to the speed of set up and the flexibility of a bridging loan, finance is taken out where funding is needed quickly and for the short term. A bridging loan can be taken out for a number of uses which include:
- Purchasing a property quickly – such as auction purchases
- Buying uninhabitable property
- Funding property restoration or conversion work
- Repossession prevention
- Buying property under market value
Types of bridging loans
There are predominately two types of bridging loans: ‘closed’ and ‘open’.
Closed bridging loan
The closed bridging loan in essence fixes the repayment date. These are normally granted if for example you have exchanged contracts but are waiting for your sale to complete. The lender will give the loan for a fixed fee based on a fixed term as they are more or less certain of a definite redemption date.
Open bridging loan
The difference between the Open and Closed loan is that the Open bridging loan has no fixed repayment date however you will normally be expected to pay it off within one year. Here the lender will usually calculate the cost over twelve months and give their loan term accordingly.
The lender in all circumstances will want to see evidence of a clear repayment or exit strategy, these include money raised from the sale of a property or a mortgage/re-mortgage of an existing property. They will also do a full appraisal of the new property you are purchasing, the price, the value and your intended plans for the property. You should also have a back-up plan in place in case your repayment strategy fails.
First and second-charge bridging loans?
When you take out a bridging loan, a ‘charge’ or security will be placed on your property in the event you default on your repayments. This is a legal agreement that prioritises which lenders will be repaid first should you fail to repay your loans.
Usually, if you still have a mortgage on your property, the bridging loan will be secured as a second charge loan, meaning that if you failed to meet repayments and your home was sold to pay off your debts, your mortgage would be paid off first.
If your home is mortgage free or you are buying a property from the auction the lender would take a first charge and in the event of default the bridging loan would be repaid first.
Cost of a bridging loan cost?
One of the major factors of a bridging loan is the cost. Due to the fact that this a short term loan, bridging loans can are quite expensive with fees ranging from 0.4% - 1.6% per month, equating to 19% per annum, far pricier that a standard residential mortgage.
In addition to the monthly interest rates many lenders will add set-up and possibly exit fees to the loan which could add another 2-3% of the loan.
Depending on the loan agreement you may be asked to pay the monthly interest in advance during the term of the loan, otherwise some lenders may roll up the interest on a compounding method.
How much can you borrow with a bridging loan?
Bridging loan lenders may lend anything between £25,000 - £25m+ however the maximum you will be able to borrow would be 75% loan to value (LTV). This would include any other funding which you may already have on the property.
For example if the lender is taking out a first charge against a mortgage free property they may be able to lend 75% LTV, however if you have an existing mortgage of 60% LTV the bridging loan will only fund a further 15% of the LTV. All lending would be subject to valuations and usual credit checks.
If you are using bridging finance to buy a property from the auction or anywhere else the lender would typically lend around 60-65% LTV meaning you would need to cover the first 35-40% as a deposit.
The application process is usually far simpler than for other types of borrowing and applications can complete very quickly, usually in 5-14 days.
The pros and cons of bridging loans
Bridging loans are undoubtedly a very useful tool when looking to raise finance, but they can be riskier than other forms of finance. As such, it’s important to carefully consider your options before proceeding and specialist advice is always recommended. There are a number of pros and cons to consider before committing to a loan:
- Quick turnaround, applications are usually completed in under 14 days, making -them ideal when funds are needed quickly.
- As there are often no monthly repayments to make, bridging finance can be used to raise capital where cash flow is tight, but you have the assets to comfortably repay the loan.
- The bridging market is very competitive with rates starting from as little as 0.37% per month, bridging finance has never been cheaper.
- Lending can often be based on the full value of the property, meaning it’s possible to purchase a property without a deposit if you are buying a property well under market price.
- Bridging loans can be used to purchase properties that are ineligible for a standard mortgage, eg properties that are inhabitable or do not have planning.
- Bridging loans are far more expensive than traditional mortgages.
- As most loans are very short term, you can face major issues if you do not adhere to the repayment terms. Failure to repay the loan at the end of the term would eventually lead to repossession, and most likely significant costs.