Bridging finance can be tricky to understand and can have a reputation for being risky and expensive. However used properly, it can enable you to do profitable deals that wouldn’t otherwise have been possible.
Here’s our guide to help you use bridging finance with confidence – starting with the very basics.
The Basics Of Bridging Finance
An easy way to think of bridging finance is to consider it just as a short-term mortgage.
In reality, it has some key differences, but bridging and mortgages have three key similarities that are worth noting for simplicity.
Firstly the amount the lender will give you is determined by the value of the property; secondly, they take a “charge” over the property as security – meaning they can repossess it if you default on the loan. Lastly, you’ll pay interest for the agreed loan term, then pay the loan back at the end.
How Does Bridging Differ From Mortgage?
The key difference is the duration: you’ll often take a mortgage out for 25 years or more, but bridging is generally for 12 months or less.
Another important difference is the cost. Mortgage rates at the moment are under 5% per year for most borrowers, but bridging tends to be 8% at the very lowest end – all the way up to 15% or more.
However other differences allow you to use bridging in creative and interesting ways, such as the fact that bridging lenders aren’t bothered about your personal income – so you can get a bridging loan even with low earnings.
The condition of the property doesn’t matter so much and bridging finance can be much quicker to arrange. Lastly, bridging lenders aren’t concerned about the rental income the property could produce.
What Is First And Second Charge Lending?
With bridging finance, lenders guarantee their loan by taking a “charge” over the property, which means that you can’t sell the property or raise money against it without the consent of the lender. It also means that the lender can force the sale of the property to get their money back if you don’t repay.
Most lending is done with just one lender, and they’re first in line to claim the proceeds when the property is sold. This is known as a “first charge” loan, but it is also possible to get a “second charge” loan with an additional lender, who simply sits behind the first in order of priority.
The first lender must agree to this though and interest rates will be higher from the second lender in this instance. A second loan can be useful however though if you have a longstanding mortgage against a property for 30% of its value which you want to keep because it has a low-interest rate, but you also want to raise additional funds.
The two loans combined can only add up to somewhere in the region of 70% in total as both lenders need to get paid back from the sale of the property if anything goes wrong.
Why Should You Use Bridging Finance?
There are three main situations where bridging finance can be useful.
The first is where you don’t want to retain the property for very long, or you want to remortgage quickly to realise an increase in value. For example, if you want to flip a property or if you want to refurbish a house to increase its value then borrow against its higher value.
The second is where time is of the essence. Because bridging can be arranged in weeks rather than months, it allows you to compete with cash buyers in situations where you can get a good deal by moving quickly.
The third is where the property isn’t mortgageable, for example, if the property doesn’t meet certain livable conditions making it attractive to renters. If you want to buy a property as a project to renovate then bridging loans are helpful in this instance.
How Much Can You Borrow?
The value of the property dictates the size of the loan; other factors like the amount of rental income and your own personal income don’t come into it. The way value is calculated can be complex, but is often calculated as ‘loan to value’.
This is the size of the loan divided by the price of the property. The “value” part in the case of bridging it’s often no different to mortgages, in that it will always be the lower of its current value or the purchase price. However, some bridging lenders will lend based on just the current market value and ignore what you paid for it.
Some lenders will also offer loans based on the Gross Development Value (GDV) – which means what the property will be worth once you’ve completed your planned works on it.
If you can find a lender who’ll lend based on market value and also contribute to the cost of the works (by lending against GDV), you’ll be able to borrow more money than you otherwise would. However remember that borrowing more means higher interest charges, which you’ll need to factor into the cost of completing the project.
How Do Lenders Work And What Do They Want To Know?
The valuation is the main factor that determines how much you can borrow and that bridging lenders will want to know.
They will instruct a RICS-qualified surveyor to inspect the property and determine its value. You may disagree with their valuation because you’ll be looking at the project optimistically and they’ll be playing it safe for the lender.
Unlike with a mortgage, the lender doesn’t need to know your ability to afford repayments, the rent the property would achieve, and so forth. But there are other factors related to you that they may want to know before agreeing. For example, what experience do you have in these projects, how you will pay them back and what income you have. The emphasis that lenders put on these factors will depend on their risk outlook and the type of lending they like to do.
Bridging Loan Fees And Structures
The interest rate is just one component of the cost of bridging, but loans also come with fees, which vary wildly between lenders.
You can roughly expect that you’ll need to pay for the following factors though: the initial valuation, an arrangement fee or facility fee, the lender’s legal fees, as well as your own; an exit fee and a whole array of other fees, depending on the lender.
A broker can be useful to help you find the most suitable deal, although they will charge a fee of their own.
The fees associated with the loan will usually be deducted from the gross advance before it’s paid over to you. The exception is exit fees, which are usually added at the end rather than deducted at the start.
As well as the fees, there’s the interest to pay, which can be deducted from the gross advance at the start, paid in one lump sum at the end or paid every month (just like with a mortgage).
How To Get A Bridging Loan
The process of getting a bridging loan is not too different from buying a property with a mortgage and is normally faster.
If you’re buying the property, the solicitor acting for you in the purchase will handle the lending element, which will include searches, insurances, checks of the Land Registry, etc. The lender’s solicitor will then check and question this information before eventually approving the loan. When this happens your solicitor can exchange and complete on the transaction, with the lender sending the funds over in time for completion day.
At a push, this can be done in a week, but a few weeks or a month is more typical.
What To Think About When Taking Out A Bridging Loan
You should consider three key factors before taking out a loan. Do you have a good exit strategy if the project overruns or if the property isn’t selling? Will your profit be enough to offset the costs? And what’s more important – the best terms or the best rates?
Working through these questions will help you determine whether bridging loans are for you.
In Summary
Bridging loans can be a useful tool, but unhelpful in the wrong hands. If you’d like to discuss anything you’ve read here, please feel free to contact one of the Prideview team and we’ll be happy to help with any advice and guidance.
