A bridging loan, if used correctly, can be a great way to procure short-term funding when it’s needed. One consequence of the economic uncertainty is the increasing number of bridging lenders on the market, which means competitive interest rates.
Bridging isn’t for everyone, and it can be riskier than other types of loan, so there are many things to take into consideration before making a decision.
What is bridging and how can it be used?
In a nutshell, bridging is a short-term loan that can support the purchase of a property, such as one that doesn’t match the criteria for a traditional mortgage. They can help between the sale of one property and the purchase of another, or help landlords at risk of repossession.
Investors might consider taking out a bridging loan to help buy and renovate an uninhabitable property that would be normally be refused a mortgage, and then take a mortgage out on it once the property is fit for purpose, or sell it at its new higher value.
Bridging has also helped a lot of investors secure properties quickly, as loans are approved within weeks, days, and sometimes hours. At auctions, when transactions generally need to be completed within one month, bridging can help to secure a property at lower than market rate within the quick time frame needed.
Borrowers might want to think of a bridging loan as a short-term mortgage, and they are similar in many ways. In both cases, the loan value is determined by the property value; and as in the case of every secured loan, assets are at risk if borrowers are unable to repay the borrowed amount. There are good reasons to take out a bridging loan, but it’s important to weigh up the negatives and positives.
- Loans can be obtained speedily and borrowers can often get instant approval
- There are rarely credit checks, and personal income is not used to decide eligibility
- There is flexibility in both the way the loan is paid back and the way the interest is paid back
- Interest rates are higher
- There are lots of fees to consider
- Assets are at risk if repayments cannot be made
First and second charge bridge lending
Basically a first charge is the primary mortgage or loan secured against a property by the lender. Most lending is on a first charge basis, and a second charge can only be secured if there is sufficient equity in the property. The first charge lender has to agree to a second charge loan being taken out. Interest rates tend to be higher on second charge loans because the risks are higher for the lender.
Open and closed bridge lending
Put simply, a borrower taking out an open bridging loan will not have an exit strategy in place, or the exit strategy will have no fixed end date. The risks are higher, and as you might expect, the rates are higher. Open loans are more often than not declined because the lender will need to know how the finance will be returned. One example of an open loan will be when there is equity tied up in a property, but it is not yet on the market.
To secure a closed loan there must be a clear exit strategy planned out, so the lender will have a clear idea of when and how the loan will be repaid. It’s in the investor’s interest to have a well thought out exit strategy, as the penalties for getting it wrong can be high. Some lenders will place borrowers in default if they are unable to pay back loans, which will affect credit ratings, some may even start the process of repossession and some will allow the loan to be extended – but will charge hefty fees for the privilege.
Fees will vary from lender to lender, but commonly incurred costs include broker fees, a valuation fee, legal costs and arrangement fees, also known as facility fees. There is also the exit fee to consider. If the loan amount required isn’t that much and the project is less risky, the lender is likely to offer better rates and fees. But if the project needs lots of money fast, fees can be higher. All fees aside from exit fees are usually deducted before the loan amount is paid.
There will also be solicitor’s fees, both the lender’s and the borrower’s. The lender’s solicitor will double check all the information sent over by the borrower’s solicitor and approve the loan once they are satisfied.
Interest can be paid back in a variety of ways. It can be paid at the beginning, along with the fees; or it can be paid in one lump sum at the end, often popular with borrowers without a regular cash flow. Or retained interest, which is a mix between the two. These are monthly repayments, negotiable depending on the terms of the loan.
How quickly can loans be processed?
As well as factoring in the speed at which it takes the lender’s solicitor to double check everything, it will depend on other factors such the time it takes for the valuation to come back, whether a primary lender needs to approve a second charge loan and how long that takes, and, depending on the lender, how much information they need on the borrower themselves. Although it varies, it should take no longer than a month: bridging loans are designed to be speedy.
How much can you borrow?
Unlike a mortgage, your personal income and rental income don’t factor into it. The bridging loan is calculated on the property value alone, but different lenders work out values in different ways.
Whereas the value of a mortgage will be whichever is lower – its current value or its buying price – some bridging lenders will use the market value, rather than the amount it sold for.
And some lenders will also calculate loans based on what it will sell for, known as the Gross Development Value (GDV). In this case, they will provide an initial loan based on the purchase price (i.e. before refurbishment) and offer a second stage of the loan once the property had been refurbished and its value has increased.
Investors who want to borrow more money for big restoration projects will need to consider how lenders calculate valuations. Lenders can take legal action as a result of any money lost as a result of an inaccurate valuation, and so they will have the property independently valued by a RICS surveyor.
Lenders will also want to ascertain a few things before agreeing to a loan. They might ask questions about experience as a property investor; how the loan will be paid back, what other assets are owned and any income that the investor gets.
Taking out a bridging loan can be a fruitful investment if everything is considered beforehand, and the pros and cons are weighed up. It goes without saying that the borrower needs to be honest about if, when and how the loan will be repaid to prevent penalties. Having a clear exit strategy with contingency plans will prevent grief later down the line.
By calculating fees and interest with different bridging lenders, borrowers can have a rough idea of costs, which should help to weigh up whether the investment will be worth it or not.
The right solicitor can ensure the transaction runs smoothly. There are solicitors that specialise in bridging loans and are accustomed to the legalities surrounding them.
A bridging loan expert will be able to tell within a few days whether they think a loan will be accepted and will offer advice on how to proceed, but with all big financial decisions, it’s best not to keep your head in the sand, and be armed with the knowledge to make the right decision in the first place.