Bridging Loans: What You Need To Know
A mixture of growing availability and booming housing market have made bridging loans an attractive choice for both individual property investors and businesses alike.
In spite of growing popularity, as more people become wise to the sheer flexibility that bridging loans offer, there are still plenty of potential investors who are still unaware of the benefits of bridging loans and how they can be used.
It is now possible to invest in products which deliver returns to investors by making bridging loans to borrowers. Once considered wholly a specialist product for high net worth investors and well-funded specialist finance companies, bridging loans are increasingly being used for a wider range of UK property investments. It’s now much more possible for lower level investors to take advantage of the benefits offered by bridging loans, particularly via development loans and P2P secured lending in property investment.
As borrowers begin to recognise the applications of the short term finance that bridging loans can offer, more are using the funding for their property investments or businesses.
Bridging loans can be used for a number of functions, including the support of residential or commercial property transactions, development or renovation projects, and also purchases through property auctions. Likewise, business buyers are using bridging loans when a quick cash injection is necessary.
What Are Bridging Loans?
Bridging loans are usually short term loans, generally 12 months or less. They can be used as a “bridging” solution until next stage or permanent funding becomes available, or until they sell a property.
Bridging loans are also, typically, quicker to secure, whilst retaining security and flexibility for the borrower. Where a quick financial boost is required, a bridging loan can come in very handy.
This financial option is used by businesses where short term funding is necessary in order to:
- Raise capital
- Settle tax liabilities
- Deal with emergencies
- Meet business obligations
- Purchase necessary items
Where an investor is purchasing a property or raising funds for refurbishment, bridging loans come in handy.
They’re suitable for:
- House Builders
- Home Buyers
- Property Investors
How Do Bridging Loans Work?
The principal difference between a regular loan and a bridging loan is organisational time taken to push the funding through. With regular lenders, it can take months to complete, but with a bridging loan, the finance can be ready in 24 hours or less.
Why Use Bridging Loans?
Bridging loans allow property investors to take advantages of opportunities as and when they arise. For example, to secure property deals, like with discounted asking prices, and also in the resolution of emergency situations where the funds would not otherwise have been available.
On the downside, bridging loans have higher interest rates than on regular loans. That’s why they’re principally used as a short term solution.
Businesses may use bridging finance for:
- Tax: if a tax demand is made, and the required amount can’t be accessed within the necessary timeframe.
- Raising capital: where a company needs to raise a sum in a short timeframe, bridging loans can be secured against property or land.
- Business Obligations: To overcome financial difficulties or meet obligations of the business, a short term bridging loan can provide a solution.
Property Owners/Homeowners may use bridging finance for:
- Repairing a broken property chain: where a homeowner is at risk of losing the home they’re set on purchasing, if a buyer in the chain drops out.
- Temporary Cash Flow: during a property transaction where a short term influx of cash is necessary.
- Downsizing: for owners who are downsizing, and therefore don’t need a mortgage, a bridging loan can help them to buy before their existing property is sold. This allows them to move independently, and quicker than if they’d had to wait.
- Quick securing of property: to prevent a buyer from missing out on the property they want to buy before their existing one is sold.
- Building a home.
- Property conversion: for those wishing to convert a barn or other property, or for developers looking to turn a profit.
Developers or Investors may use bridging finance for:
- Development and renovation projects.
- Fast access to funds (as above).
- Un-mortgageable properties: for fixing up dilapidated properties for which a mortgage wouldn’t be approved, a bridging loan can give investors the chance to renovate and sell at a profit.
So How Much Could I Borrow With A Bridging Loan?
As with any loan, it depends both on your circumstances and on the lender themselves.
Generally, the minimum you could borrow would be about £10,000. At the upper end of the scale, the limit is usually £1,000,000, though some lenders can go significantly higher than the £1,000,000 mark.
The structure of bridging loans does differ from one to another. Some bridging loans allow the borrower to just pay off the interest each month, and repay the loan at the end of the term. This structure is generally most suitable for those who will have access to regular cash flow throughout the duration of the loan, enabling them to meet the monthly interest payments. Alternative options include retained interest or “rolled up” interest.
“Rolled Up” Interest
This means that, rather than paying the interest every month during the term, the interest is effectively “rolled up” and paid at the end of the term. This is an option usually considered by borrowers who won’t be able to make interest payments monthly during the term, until the lump sum comes in at the end allowing them to pay back the loan and interest in full. In this case, however, the interest is typically compounded, meaning the repayment at the end of the term will be larger.
Sometimes, it’s possible for a borrower to retain an amount from the loan representing a number of monthly interest payments, to help them meet those monthly interest payments. This option allows the borrower to choose the number of months, dependent – of course – on their affordability criteria. As the retained interest is still a part of the capital loan sum, interest will be charged on this amount. Equally, the total loan must be within the loan to value figure.
By the time the loan is redeemed, if there remains any unused retained interest, the lender tends to offer the borrower credit for this amount.
This, again, depends on the lender. The actual rate of interest a borrower will pay also depends on:
- The borrower’s credit score
- The Loan to Value (LTV) – typically 70% – 75%
- Whether it’s an open or closed bridging loan (see below)
- The type of security the borrower can supply
The reason that the interest rates on bridging loans are usually higher than on mortgages is that the lender engenders more risk through bridging loans.
Typically, you can expect to pay between 1% and 1.5% interest per month, plus a 1%-2% arrangement fee or broker fee.
Whilst the process of funding with bridging loans can take as little as a few hours, depending upon the circumstances, it usually takes between a week and a month. In the case of a complex development loan, for example, it could take even longer. This is because these sort of complex loans need to meet a number of conditions, which will have to be discharged by the LPA (Local Planning Authority).
Paying It Back
You will, as with any loan, be expected to pay it back by the end of the term. The interest payments can be paid in whole when the total sum is repaid, retained from the loan at the commencement, or simply made via monthly installments.
Bridging Loan Periods
As mentioned, bridging loans are usually lent over a maximum 12 month period. It’s more practical for these higher interest loans to be simply short term solutions. Nonetheless, you can usually pay it off at any time within the given time period, if your finance comes in sooner.
It’s important, with bridging loans, to look at the overall cost of the loan, including all fees, rather than focusing solely on the interest rate charged.
The Two Types of Bridging Loan
In this type of bridging loan, the borrower is required to set out a proposed exit plan for the repayment of the loan, but at the outset there’s no definitive date set. With an open bridge, a cut-off point is defined by which the loan must be repaid.
As above, the borrower has to meet a set date for the repayment of the loan. If the borrower, for example, has already exchanged on the sale and has a fixed completion date. The bridging loan will be repaid by the sale of the property.
Will I Need Legal Advice?
It’s always recommended that, when instigating a bridging loan application, the borrower engages an independent solicitor before signing any legal documents. This will ensure that both you and the lender are protected.
Finding A Reputable Lender
It’s important to ensure you are dealing with an accredited, reputable lender when obtaining a bridging loan. Make sure that the one you choose is:
- A Member of the Council of Mortgage Lenders
- Is both authorised and regulated by the Financial Conduct Authority (FCA)
- Has experience working on similar projects to yours
- Has a proven track record in the field
Increasing numbers of property buyers and investors, both business and individual, are recognising the usefulness of bridging loans for short term funding. If it sounds like an option that might be useful to you, then make sure you do plenty of research before getting involved!
As always, don’t forget to check out our current investment opportunities, and register with us to find out more about investing with The House Crowd.