What are bridging loans and how do they work?
Bridging loans are designed to help people complete the purchase of a property before selling their existing home by offering them short-term access to money at a high-rate of interest.
As well as helping home-movers when there is a gap between the sale and completion dates in a chain, this type of loan can also help someone planning to sell-on quickly after renovating a home or help someone buying at auction.
As banks and building societies have grown more reluctant to lend in the wake of the financial crisis, there has been an influx of bridging lenders into the market.
However, rates can be high and there can be hefty administration fees on top. Indeed, potential borrowers are warned there is a risk of getting ripped off unless you proceed extremely carefully.
If you take out a bridging loan, you could face costs of up to 1.5% a month - meaning 18% a year.
As well as helping home-movers when there is a gap between the sale and completion dates, this type of loan can also help you if:
- You’re planning to sell-on quickly after renovating a home
- You’re buying at auction
Am I eligible for a bridging loan?
There are a number of considerations loan providers make when considering eligibility for a bridging loan:
- Loan providers may only offer bridging loans to customers who also get their new mortgage from them as well – but this isn’t always the case
- Loan providers usually require property as security, and depending on the loan and provider you may need to own more than one property to qualify
- You may have to show proof of income, but as the loan interest isn’t paid on a monthly basis this isn’t always needed
- You may need a business plan if there’s a commercial aspect to your plans
- If you’re planning to develop property, you may need to provide your track record in property
What types of bridging loans are there?
You can choose between a closed bridge loan and an open bridge loan:
- A closed bridge loan requires you to know exactly how you’ll be paying off the loan. This means you’ll be able to tell the lender what funds you’ll be using to pay off the loan from the outset – this is often called an ‘exit plan’. Closed loans are usually settled within a few months.
- An open bridge loan usually doesn’t require an exit plan and is often used as a means to get funds for an urgent transaction. As you won’t have to provide a detailed plan of how you’ll be settling the debt, open bridge loans can be a time-effective solution. You’ll usually have up to a year to repay your debt.
How to get the right bridging loan
To make sure you’re choosing the right kind of bridging loan, here’s what you should consider:
1) Is this a first charge loan or second charge loan?
A second charge loan applies if you already have a loan secured against a property that already has an outstanding mortgage. So for improvements such as extensions, you’d need to take out a second charge bridging loan. The distinction lets the lender know who has priority in the repayment if you can’t pay off the loan by the end of the term. If however you’re taking out a new loan secured against the property, you’d qualify for the first charge loan.
2) Are you paying fixed or variable rates?
If you prioritise stability, a fixed rate interest will ensure you know exactly how much interest you’ll be paying throughout the rest of the term. This is because the rate is agreed upon beforehand, but you may end up paying more as you pay for the security. Alternatively, a variable rate is subject to change, but you may save money depending on the base rate. So if security isn’t all-too important, a variable rate gives you a chance to save when market interests are in your favour. If interest rates are low and on the verge of a spike, it’d be best to lock in your loan at that fixed rate.
What are the interest rates on bridging loans?
As the loan period of bridging loans tend to last a few months, you can pay your interest in several ways:
- On a monthly basis: You pay the interest separately and the sum isn’t added to the loan balance
- In a rolled-up deal: Where you’ll pay the compound interest in full along with the loan when repayment is due
- Retained interest: Where your monthly interest payments are covered until an agreed upon date so you can then pay back the full sum when the money is due
What can you use a bridging loan for?
Bridging loans are used most commonly used by landlords, homeowners, and property developers to:
- Buy property
- Initiate property development
- Invest for buy-to-let purposes
- Pay tax bills
Advantages and disadvantages of a bridging loan
There’re a number of advantages when opting for a bridging loan for high-cost transactions:
- You’ll receive your money quickly
- You can borrow a large amount of money – up to £250 million
- Flexible borrowing might apply
The drawbacks to bridging loans include:
- The loan is secured against your property, so you risk losing ownership if you can’t meet the repayment
- The high interest rates that come with the loan – this is because you pay for the flexibility and swift payment
- You’ll be charged a number of fees so it’s a costly option
What kind of fees are involved?
Bridging loans are known to charge a large number of fees in addition to the interest you’ll have to pay, including:
- An arrangement fee for the loan set-up. This is often 1-2% of the sum of the loan you borrow
- Some providers allow you to pay back your dues early which will then be charged as an exit fee of around 1% of your loan
- You’ll have to pay a repayment fee for the cost of the administration including the paperwork
- Valuation fees cover the surveyor costs
How much can I borrow?
You can borrow between £5,000 and £250 million, depending on the value of the property you are securing the loan against. If you put a number of properties forward, you’ll be able to borrow more. Lenders will provide you with a quote based on the loan to value (LTV) which can range from 65% to 80%.
Where can you apply for a bridging loan?
Major banks, mortgage brokers and specialist lenders provide bridging loans. These loans aren’t easily accessible, and you’ll usually need to discuss your situation directly with the bank to know exactly what’s being offered in a deal.
How long does it take to be approved for a bridging loan?
You’ll usually receive a decision within 24 hours of submitting your application. After which you’ll have to wait roughly 2 weeks for the necessary checks and balances to be processed including property valuations and the money transfer itself.
A development loans is also a short-term loan for property developments including refurbishment and construction and is based on the gross development value which you’ll pay back in stages.
Remortgaging works very similarly to a bridging loan with the key difference being that this is a long-term loan, usually between 25 to 35 years and requires a lengthy application process.
A personal loan is always an option if you can borrow sufficient funds for your transaction but you’re likely to pay higher interest rates than you would with a mortgage.