If you’re looking for a solution to a short-term financial conundrum, you’ve probably come across the term ‘bridging loan’.
If you’re unsure of what they are, when they can be used, and how much they are likely to cost, you’re in the right place. We’ll answer all those questions, and more, in today’s post, Bridging Loans Explained.
What are bridging loans?
As we alluded to in our introduction, bridging loans are short-term ways to borrow money and they’re commonly used as ‘bridges’ between buying one property and selling another.
What can bridging loans be used for?
Customary uses for bridging loans include:
- ‘Bridging the gap’ when a property chain falls through.
- Buying property at auction.
- Buying a buy-to-let property quickly without a deposit or mortgage in place (often referred to as ‘bridge-to-let’).
- Buying a fixer-upper that is currently deemed to be unmortgageable.
- Property development.
Bridging loans are not restricted solely to property use but, as we’re writing a property blog, that’s what we’ll stick to here today.
How do bridging loans work?
Bridging loans differ from regular mortgages in that they are not tied to your income.
The amount you can borrow with a bridging loan is dizzying, from £50k up to £10m, but they are not without risk. Bridging loans need to be secured against something, usually one or more properties, and whatever is used as security is at jeopardy should you not be able to repay the loan.
Loan amounts are dependent on equity, with the highest amount usually restricted to 75% loan to value (LTV). This amount includes interest.
Repayments are discussed up front, with the lender expecting to see your exit strategy in advance of the loan being granted. Exit strategies can be wide-ranging, but some of the most common include:
- Cash Redemption: Used when an expected lump sum, such as an investment maturing or pension paying out, is expected in the short-term.
- Property sale: Probably the widest used exit plan, this is where the homeowner purchases a property prior to the sale of their own home going through. The repayment will be made once the sale completes.
- Flipping: Buying a property to refurbish and resell. Repayment will be made once work has been completed and the home has been resold.
How is interest calculated on a bridging loan?
As bridging loans are widely regarded as short-term fixes, it’ll come as no surprise to learn that interest rates are usually higher than that of standard mortgages. Interest rates can range from around 6 to 20% APR.
What does sometimes come as a shock to the uninitiated is that the interest is commonly charged daily. This, again, is due to the short-term nature of the loan. Another difference is the way in which you’ll be charged, which will be by one of the following methods:
- Monthly repayments: Akin with interest-only mortgages where only the interest is paid every month and it is not added to the principal.
- Rolled up: Interest is added to the principal and settled when the loan itself is paid in full.
- Retained: Interest is borrowed in advance for a designated period of time. Once the bridging loan has been repaid, the remaining interest is returned.
What other costs are associated with bridge loans?
It’s important to note that bridging loans may incur other fees on top of interest repayments. These can include:
- Admin fees.
- Arrangement fees.
- Valuation fees.
- Broker fees.
- Legal fees.
What you’ll pay for each of these will vary dramatically, as many are tied to a percentage of the loan. Obviously, you should always check what you’ll be paying before you sign anything!
Are there different types of bridging loans?
Yes, there are two types of bridging loan: Open and Closed.
Open bridging loans
Open bridging loans have no fixed date for repayment. You will, however, usually be expected to repay the loan in full within a year.
The average term, according to Bridging Trends, currently stands at around 11 months. So, it would seem that bridging loans are being used for the maximum duration by many of those looking for this particular finance option.
Closed bridging loans
Yes, you guessed it, closed bridging loans do have a fixed repayment date. As such, you will often find the rates will be more favourable and the likelihood of being accepted will increase.
What’s the difference between first charge and second charge loans?
Taking out a bridging loan results in a ‘charge’ being added to the property you put up as security. In the most basic terms, first and second charges are simply a way of prioritising what gets paid and when should the property be seized and sold in order to repay any outstanding debts. First charge loans get paid first, second…second!
So, how are these charges applied? It’s a good question, and it all comes down to whether or not there are any other existing loans secured against the property.
If, for example, you don’t have a mortgage and there are no other loans associated with the property you intend to secure the bridging loan against, the bridging loan itself would become a first charge loan. This means the bridging loan will be paid off first should the seize and sell scenario come to pass.
On the other hand, if you already have a mortgage on that property, the bridging loan would be deemed a second charge loan because the mortgage will always be classed as a first charge loan. The mortgage will then be prioritised before the bridging loan and paid off first.
Second charge loans are more difficult to secure than first charge loans, as you’ll need to obtain permission from the lender of the first charge loan before you can proceed. They are also, usually, more expensive.
Bridging loans: Pros and cons
So, now we know a little more about bridging loans and the purpose they serve, let’s get an overview of their advantages and disadvantages:
- Bridging loans can be obtained far quicker than a standard mortgage.
- They also allow you to finance purchases that ordinary mortgages will not cover.
- The amount you can borrow is considerable, anything from £50k up to £10m.
- You have the ability to arrange your own repayment terms by way of your exit strategy.
- They are available for a wide range of property purchasing scenarios.
- Many bridging loans will be offered without early repayment charges.
- High interest rates, often in the region of 6% to 20% APR.
- Additional fees can also quickly add up.
- Security is essential, so your assets are at risk when taking out a bridging loan.
Alternatives to bridging loans
While bridging loans offer the perfect solution to some, for others there may be better options available. These include:
- Remortgaging your property.
- Secured loan.
- Personal unsecured loan.
- Let-to-buy mortgages.
- Asset refinancing.
If you are in any way unsure about whether or not a bridging loan is right for you and your own individual circumstances, speak to a financial advisor.
Whether you’re a landlord or homeowner, if property in the capital is your thing you need to have Petty Son and Prestwich by your side. Since 1908, we have been helping people achieve their property goals with our people-first ethos. Want to know what makes us different? Give our friendly team a call to discuss your next move to find out.
Catherine has been in estate agency since 1986 and her local knowledge is second to none, despite being from Bonnie Scotland! A Loughton resident of 33 years and one of the finest Sales Managers there is, Catherine is a true professional.020 3370 8781 / Email Directly