Understanding Bridging Loans
Bridging loans have become more prevalent in recent times; the market has grown from £1 billion to over £8 billion in a decade and continues to grow.
It is a unique finance facility used mainly in the property sector but is still a mystery to most people,
In this article, we will look unravel the mystery and understand what the loan is and how it functions.
A bridging loan, sometimes known as a swing loan is a type of short-term loan that can be used for residential and commercial estates. It bridges the gap between one's cash flow needs and completing a property deal.
The loan is secured against the borrower's asset, and typically this will be a property.
Many home buyers take a bridging loan to help them buy a new home before they sell their existing home. The period and money gap can be filled with the help of this type of loan and make the housing process smooth.
It allows the person to move into their new home early, and then they can focus on selling the old one to repay the loan.
How does a Bridge Loan work?
Typically bridging loans are obtained from a specialist lender, although some banks may also offer this type of finance.
As mentioned earlier Bridging loans are short term loans which typically means the borrowing period would be from a few days and up to 12 months.
And because these loans are secured against a property, the application process is swift, unlike a standard mortgage which can take months in some cases, a bridging loan you can get the capital in your account within days.
As such they are popular for buying a property at an auction as you may need the cash quickly.
Interest Rates & Costs Associated with Bridging Loans
Also, unlike a standard mortgage, bridging loan interest rates are calculated on a per month basis rather than yearly, and they are much more expensive. Typically, monthly interest starts from 0.40% and can go up to 1.5%.
The rates you get will depend on your security against the loan and the risks to the lender.
Overall, they bridging finance is much more expensive than say a standard mortgage which is 3 to 5 percent per annum. This is due to bridging loans being shorter and riskier.
With bridging loans, the interest rates can be retained or rolled up to pay back the interest at the end of the term loan.
There are also other charges the lender will levy, and these fees include arrangement fee (typically 1% to 2% of the loan amount), admin fees, valuation fees (on a £500,000 property it would be around £600), solicitor fees and sometimes exit fees.
Pro tip: It is always a good idea to read your terms carefully as lenders may have hidden charges on their terms.
You can borrow up to a maximum of 80% loan to value (LTV) of your secured property. Keep in mind, the higher loan to value you acquire, the higher the interest rates are likely to be.
Open vs Closed bridging loan
A closed bridging loan is one with a clear exit strategy by the borrower; for example, a borrower is looking to buy a new home and will pay back the loan on the sale of his existing property.
On average, these loans are borrowed for about five months and paying back the loan earlier saves you money on the interest, and with bridging loans, there are usually no penalties to pay back sooner.
An open bridging loan is one that does not have a clear exit strategy; they are also typically 12 months but can be extended to 18 months. An open bridging loan is also more expensive than a closed one as the risks are more significant to the lender.
An example would be for a property developers looking to build apartments; there may be delays involved in the build as thus, he may not know the exact time to pay back.
Regulated and Un-Regulated Bridging loans
A regulated bridging loan is one which the borrower uses his live-in home or family's home as security against the loan. It is then regulated by the Financial Conduct Authority (FCA), and the borrower has certain rights, meaning borrowers have protection under the Mortgage Code of Business (MCOB) rules.
An unregulated bridging loan is typically used on a commercial basis and is not subject to regulation by the FCA.
Who would benefit and use a Bridging Loan?
- Homeowners looking to buy a new home
- Property Developers (for property developments)
- Buying property at an auction
- Builders
- Businesses buying property
Bridging Loan Example:
Mr Smith is looking to downsize and has found a home he wants, but to purchase his house, he needs to sell his existing home to pay for it as he doesn't have the cash with him.
As not to lose the purchase of the new property, he contacts a bridging lender to obtain the cash to purchase the property.
The application is completed, and the lender does the due diligence on his existing property.
The current home he owns is put up as security against the loan he borrowed.
Thus, when the existing home gets sold, he pays back the lender and the charges included.
The Bottom Line
Bridging loans are a necessary and beneficial form of finance. When you understand what they are and how they can be used. It is advisable to get help from a finance expert to know if they would be the best fit for you.