A bridging loan is a form of short-term lending, secured against a property. Bridging finance can support cash flow before a more long-term arrangement can be made. Bridging loans are often seen as ‘bridging the gap’ between property purchases, if a chain collapses during a property transaction, however, are also very common in cases of property investment and development.
In this article we will be discussing how to assess your financial needs for a loan, understanding the variations in bridging loan types and key factors to consider when choosing a bridging loan.
Overview of the Bridging Loan Process
Bridging loans are normally short-term loan arrangements for 1 to 24 months, with interest charged monthly and interest payments available on a serviced or retained basis. Whilst the outstanding debt would normally reduce over the term with a capital repayment mortgage or personal loan, a bridging loan balance will normally increase over time or remain stable, only repaid in full at the end of the term. Therefore, delays in your exit and redemption can cost you money.
Assess Your Financial Needs and Goals
To support your decision in choosing the right bridging loan, it’s important you are firstly clear on your loan purpose, the amount you want to borrow and for how long. Setting these parameters allows you to filter out providers that don’t meet your needs and make specific enquiries to a lender with confidence.
Define Your Loan Purpose:
Clarify the specific reason for needing a bridging loan and how the loan will address your financial situation. Are you using the funds to buy a property, renovate a house, or inject money into your business? It is important you provide as much detail as possible and approach your enquiries with lenders with transparency to build trust and open communication.
Determine the Loan Amount:
Calculating the amount of money you need to borrow will vary based on your circumstances. However, it is crucial to accurately anticipate what money you require, as borrowing more than you need can cost you unnecessary interest. Whereas having insufficient funds may mean you are unable to complete your property project on time, leaving you desperately trying to access more money to finalise your investment.
Estimate the Loan Duration:
Consider overestimating your required loan term and understanding your flexibility for repaying the loan early. Bridging loans only have a term of circa 1 month to 2 years and are therefore intended to be a temporary form of finance. This in turn means that there needs to be an intended repayment vehicle for a bridging loan. There are several possible exit strategies to a bridging loan, with the most common involving either a refinance, sale of the property or sale of another asset. The sale of a property typically takes 3 to 6 months to secure an offer and another 3 to 6 months to complete. However, you will need to research the property market and speak with an estate agent for advice. Refinancing your loan will take different amounts of time depending on the lender, their requirements for supporting documentation, valuation and legal work. If further searches are required, or there are delays with the legal process, this can take anything from weeks to months.
Understand the Types of Bridging Loans
Closed Bridging Loans:
Closed bridging loans come with a fixed repayment date, making them ideal for borrowers who have a clear exit strategy for repaying the loan. Most common in residential property transactions where there is a break in the chain, a sale may be agreed against their property but there are delays to expected completion, therefore the exit is already lined up.
Closed bridging loans are usually lower-risk for lenders compared to open bridging loans (which have no set repayment date) because the exit plan and repayment timing are defined upfront. Due to this reduced risk and certainty, interest rates may be somewhat more favourable than with open bridging loans.
Open Bridging loans:
In contrast, open bridging loans do not have a fixed repayment date, making them suitable for borrowers who need temporary financing but lack a definite exit strategy. These loans are often used in situations where the borrower is awaiting uncertain events, such as the sale of a property without a confirmed buyer, or the securing of a term mortgage that has not yet been finalised.
First-Charge vs. Second-Charge Bridging Loans
A second-charge bridging loan is secured lending, taken in addition to an existing loan you have outstanding against your property with a different lender.
It uses the capital (or equity) in your property as collateral and is based on the difference between the value of the property and the amount you owe on your first mortgage/charge. This additional charge ranks after your existing secured loan. Therefore, if the property was to be repossessed, the first-charge lender would have the primary right to have their loan repaid, followed by the second-charge lender.
Whether a lender offers second charge lending can vary, however as it is regarded as higher risk, it will come with a higher interest rate.
Key Factors to Consider When Choosing a Bridging Loan
Interest Rates and Fees
Interest rates for bridging loans are normally displayed on a monthly basis, such as 1.00% PCM, this would be the equivalent of an annual rate of 12%. Aside from the monthly rate, it is also important to establish whether your lender calculates interest on a daily or monthly basis and whether they apply compound interest. The benefit of interest being calculated daily is that if you were to pay back your loan halfway through a month, you would only pay interest for the days your loan was outstanding and not for the full month. Whereas in this circumstance, if interest was paid monthly, you would be charged interest for the full month.
Compound interest is when the interest you are charged, accrues interest. This means that the original debt is increasing month on month at an exponential rate.
- If you borrowed £100K at a rate of 1% PCM, the figure would grow as follows: Month 1 = £101,000 / Month 2 = £102,010 / Month 3 = £103,030.10 / Month 4 = £104,060.40 / Month 5 = £105,101 / Month 6 = 106,152.01. In this example over 6 months, £6,000 would have been accumulated in simple interest from the original loan sum, however an additional £152 has also accumulated from the added interest that has compounded.
Loan-to-Value (LTV) Ratios:
The loan-to-value ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. So a loan at 70% LTV means you are borrowing the equivalent of 70% of the property’s value. The higher the LTV the higher risk the loan, from the lender’s perspective, and so this can warrant a higher interest rate or more stringent criteria. Maximum LTV rates will vary amongst bridging loan providers and will depend on the type of security, its condition and the planned future use of the property. To assess a property’s LTV limits you need to establish how the lender will assess the property’s value. They may use the market value, investment value, Gross development value or 180-day value. The final value may also be subject to a formal valuation report being completed at cost to the borrower.
Repayment Flexibility:
One factor that can impact the net loan figure is whether your monthly interest is serviced or retained. Retained interest will be deducted in advance from the gross loan, calculated from the loan term. Whereas with serviced interest, only one month’s interest would be deducted in advance from the gross loan, allowing for a larger net loan figure. However, the monthly interest accrued would then need to be cleared monthly from your income. The net loan is the amount of money the borrower receives from the lender and the gross loan is the money they will need to pay back.
The benefit of retained interest is that you won’t need to provide supporting documentation to prove that you receive sufficient income to meet the monthly payments and those funds can then be utilise elsewhere towards your property investment.
Exit Strategy Requirements:
Lenders require an exit strategy, because your loan is only cleared in full at the end of the loan term. As part of underwriting your loan a lender will need to consider the plausibility of your planned exit within the loan term provided. If the exit does not make sense or seem possible, this could impact the approval of your loan. Examples of supporting evidence to document your loan exit are as follows; A formal loan offer for a term mortgage, an active advert marketing your property for sale, an agreed offer Heads of Terms letter. Be clear on your lenders requirements so you can collate the necessary information ahead of time.
Questions to Ask Potential Lenders
How Much Does a Residential Bridging Loan Cost?
Including interest rates, fees, and additional charges. At BIG we are very transparent about the applicable costs for any loan at the point of enquiry. Common costs include your monthly interest rate, an admin fee, arrangement costs, valuation fees, solicitors’ costs, broker fees and exit fees. Advocate for yourself and gain clarity on everything you will need to pay.
What Happens If I Miss a Payment?
Inquire about the lender’s policy on missed payments, including potential penalties and interest rate adjustments. Whilst no one plans to miss payments on their loan commitments, don’t be left in the dark on what the charges could be. Otherwise there may be an unfair pricing structure that you are agreeing to and get caught out later.
How Quickly Can I Get the Funds?
Knowing the lender’s average timeline to provide funds is crucial, as most bridging loan requirements are time sensitive. Choosing a lender based on rate alone is not the full story. Discuss a clear timeline upfront and if they can meet this.
What Are the Terms if I Repay Early?
It is also important to ask about early repayment terms, penalties, or exit fees to avoid unexpected charges if the loan is settled before the term ends. You are unlikely to want to keep your loan for the full term, as it is normally financially beneficial to clear your loan earlier where possible. However, if you will be penalised for early repayment, this may impact the term you request or what exit plan is most suitable.
