Top 5 Mistakes to Avoid When Taking Out a Bridging Loan

– Introduction
– Mistake #1: Not Understanding the Cost Structure
– Mistake #2: Failing to Have a Clear Exit Strategy
– Mistake #3: Overestimating Property Value
– Mistake #4: Choosing the Wrong Lender or Loan Type
– Mistake #5: Ignoring the Risk of Default
– Conclusion

Bridging loans provide fast finance secured against property. They’re intended to be a short-term fix to a temporary shortfall in funds.

Bridging loans are common in residential property transactions when there is a break in the purchase chain, then can also be utilised to support a business’ growth/investment goals, purchase a property at auction or for other urgent cash flow requirements.

In today’s article we will be considering potential pitfalls associated with bridging loans to help you avoid the financial strain, disappointment and extra costs that can happen because of some common mistakes.

• Common Pitfalls:
  • Borrowers often underestimate the total cost involved, 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.
  • Lack of clarity on compound interest and how quickly costs can escalate. 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 = £101K / 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.
• How to Avoid It:
  • Ensure a comprehensive understanding of all costs associated with the loan. Explore what additional costs are incurred if you were to fall into default on your loan and any other potential scenarios.
  • Get a breakdown of fees from the lender and use a bridging loan calculator to estimate total repayments if required.
• Tips:
  • Ask for a written explanation of all charges before signing any agreement.
  • Consider seeking advice from a financial advisor to assess affordability.

• Common Pitfalls:
  • Many borrowers are caught short with their exit strategy, by failing to accurately anticipate how long it may take to obtain the necessary funds to repay their loan.  Refinancing your bridging loan onto a term facility with another provider is one of the most common exit strategies, which could take circa 6 weeks if everything goes smoothly. However, if there are delays in the process, such as requirements to complete a valuation or additional property survey, application declines, underwriting enquiries or delays at the land registry or with your legal team then an application can take months. Potentially taking you past the end of your loan term.

o   Relying solely on a property sale or unpredictable income to repay the loan: Borrowers often overestimate how quickly they can sell a property or the sale price, leading to longer loan periods and higher costs.

• When using the sale of a property to repay your loan, the timeline is completely indeterminate dependant on the property market and demand for property in that area. Whilst you may have a desirable and well-presented property for sale, there may not be sufficient buyers available willing to pay the asking price, or there could be delays in the purchase process that prevent a quick sale. Selling at auction can avoid some delays, but also means you are likely to get a reduced price for your property.

• How to Avoid It:
  • Develop a clear, realistic, and executable exit strategy before taking out the loan.
  • Consider multiple exit options so you have a plan B (e.g. sale of another asset, refinance, or property sale).
• Tips:
  • Try consulting the professional advice of a mortgage broker or other financial advisor who can take some of the burden of completing a loan refinance or planning a suitable strategy.
  • Regularly review and update your plan to ensure it remains viable.

Common Pitfalls:

• Relying on an optimistic valuation without market research. When an investor is focused on their own property project, it is very easy to get carried away and have a biased view of its value. Investors can also consider the investment value or income value of an asset, however your lender may only be considering the bricks and mortar value. Every lender will therefore need to complete their own due diligence or instruct a formal valuation to establish the property’s true value. This may be based on a market value or 180-day valuation (the value of a property sold within a restricted marketing period, such as at auction.)

• How to Avoid It:
  • Conduct thorough market research or seek a professional valuation.
  • Be conservative in estimating the property’s value and the time required to sell.
• Tips:
  • Use multiple estate agents’ valuations to get a more balanced view.
  • You can complete your own research using sites such as Rightmove, where previous sales information is available from the last few years. By comparing recent sales in the local area of similar properties, you can build an understanding of average £ per square foot.
  • Have a contingency plan if the sale is delayed or the property achieves a lower-than-expected price.

• Common Pitfalls:
  • Borrowers may rush into selecting a lender without comparing options or understanding different loan types. Whilst you may have a time sensitive transaction and be keen to find a quick deal, you can’t be too hasty selecting the right lender.
  • Not reading the fine print, resulting in unfavourable terms and conditions. Don’t get caught out discovering you have already agreed to restrictive or unfair loan terms after its too late.
• How to Avoid It:
  • Compare multiple lenders and bridging loan products to find the most suitable option. A broker or financial advisor may be able to help you compare multiple loans and firms very quickly.
  • Look beyond the interest rate and consider other factors like fees, flexibility, and reputation. Is a bridging loan right for you? How quickly can this firm provide funds? What’s the application process? What requirements will you need to meet?
• Tips:
  • Use comparison websites and consult a bridging loan specialist for advice.
  • Read reviews and testimonials about potential lenders to gauge their reliability and customer service.

• Common Pitfalls:
  • Borrowers may not consider the full implications of defaulting on a bridging loan, including losing the property and damaging your credit score. If you are unable to repay your loan within the term provided, it will be in default, unless another formal agreement has been made with your lender. Once in default, your lender may apply a higher interest rate and potentially take legal action, which could involve the repossession of the property. Failure to meet repayments can also be reported to credit reference agencies, with a default showing for 6 years on your record.
  • Underestimating how quickly financial circumstances can change. Whilst you may initially be in a strong financial position, able to meet monthly loan repayments and have no financial concerns. If funds are reliant on another business venture or market conditions, such as rental income, finances can shift unexpectedly and leave you in a vulnerable position.
• How to Avoid It:
  • Review all potential risks and worst-case scenarios with a financial advisor.
  • Ensure a buffer is in place for unforeseen circumstances, such as market changes or delays. This could involve having an emergency fund available or other sources of short term credit, like business loans/overdrafts.
• Tips:
  • Have a contingency fund available to cover unexpected costs or delays.
  • Choose a loan with flexibility for extensions or payment holidays if needed.

In conclusion, to avoid making common mistakes with your bridging loan application; ensure you have a comprehensive understanding of all costs associated with your bridging loan, have a contingency fund available to cover unexpected costs or delays, consider seeking advice from a financial advisor and compare multiple lenders and bridging loan products to find the most suitable option.

How else will you take proactive steps to ensure a smooth borrowing experience with bridging loans?

Have you considered contacting a financial advisor or a mortgage broker to get personalised advice? For more information on your bridging finance options, contact BIG Property Finance on; info@bigpropertyfinance.co.uk – 0121 348 7830.