What Is a Bridging Loan?
A bridging loan, or bridge loan, is a type of short term, interest-only borrowing which can be used to fill in for capital held up in a property while you are waiting for other funds to clear.
It allows you to buy new property if you don’t have capital at the time of purchase, but are expecting to in the near future.
For example, if you have exchanged contracts on your home but have not completed the sale, or if you decide to buy a house at auction.
Continue reading for the full details of a Bridging loan and the pros and cons.
Bridging Loan: Why Would I Need One?
There are a number of reasons you might consider taking out a bridging loan. In all cases, they are used to ‘bridge the gap’ between buying one property and selling another. Some common instances in which bridge loans are used include:
- Property chain breaks. If you were ready to move into a new home, but the buyer for your current home pulled out at the last moment, a bridging loan could allow you to finance the new property while you find another buyer.
- Buying property at auction. At the auction, you will be required to pay upfront for the property; if you are planning on financing the purchase with the sale of another property, a bridge loan could help to tide you over until the sale is complete.
- Buying property for renovation. If a property needs a lot of work doing or is missing certain features, such as running water, mortgage lenders could deem it ‘uninhabitable’ and refuse to lend. A bridging loan could help you to finance the renovation until the property is either ready to sell on, or in a state where it can be remortgaged.
- Shopping for a mortgage with bad credit. If you are struggling to get a mortgage for a property because of a known issue that’s hurting your credit file (and expect to resolve the issue in the near future), you could consider using a bridging loan to secure the property until your credit is repaired and you can get a mortgage
Bridging Loan: Who Can Get One?
Bridging loans are available to anybody needing property finance who can provide evidence of a watertight repayment strategy and a deposit of at least 25-30%.
Bridging loans are generally more flexible than mortgages because whether or not you qualify based on the repayment strategy you present to the lender, rather than your credit history. However, without a solid repayment strategy, you will not be able to obtain a bridging loan- no matter how good your credit score is.
Bridge loan lenders normally require you to have a deposit of 25-30% of the value of the property you want to buy. Although it is possible to find lenders who will ask for less of a deposit, these loans are likely to have very high-interest rates.
Bridging Loan: What Are Acceptable Repayment Strategies?
The repayment strategy is the most critical factor in securing a bridge loan. You will need to prove to your lender that you have a solid plan in place for how you will repay your debt, so it is important to think carefully about your circumstances and prepare thoroughly before you apply.
Bridging Loan: Moving House
If you are using a bridge loan to move into a new home while you wait on the sale of your old house, a lender is likely to want to see an offer on the table. If you can’t show them this, they might consider other factors, such as your home’s value, location and desirability
Bridging Loan: ‘Temporary Mortgage’ Due to Bad Credit
If you are applying for a bridge loan because you can’t get a mortgage due to bad credit, you will need to think carefully about your repayment strategy. If you are planning to remortgage in the future to pay off your bridge loan, you will need to convince your lender that your credit will have improved sufficiently in future that you will be accepted for a mortgage.
You should also be sure that you can afford repayments: just like a mortgage, a bridge loan is secured against your property, so if you don’t keep up with repayments, your home could be at risk.
Bridging Loan: Property Development
If you are using a bridge loan to fund property development or renovation, you will need to present plans to your lender about how you will achieve this.
They will consider a number of factors, including whether you have planning permission, any previous experience, how resilient your plans are to potential setbacks and how ‘saleable’ the developed property is likely to be.
Bridging Loan: Buy-to-Let: Regulated v Unregulated Lenders
Bridge loan lenders in the UK fall into two categories- regulated or unregulated.
Regulated lenders are overseen by the Financial Conduct Authority, which works to protect consumers and set minimum industry standards. If your lender is regulated, they will only be able to accept a repayment plan based on how much the property you are taking out the loan for will be worth in future. Under Financial Conduct Authority rules, they cannot consider the income you might get from other sources, such as rent.
If you are planning to repay your loan using rent from the new property- or any other non-standard potential source of income- you will need to look for an unregulated lender. Most bridging loan lenders in the UK are unregulated.
Bridging Loan: How Long Can I Borrow For?
Unlike a mortgage, bridge loans are not intended to be long-term loans. They are expensive, and should not last for more than a few years at most. When you take out a bridge loan, you will need to decide whether you would like your loan to be ‘open’ or ‘closed’.
Closed bridging loans have an agreed end date. If you know exactly when you will be able to repay your loan (for example, have already exchanged contracts on a house move), a closed bridging loan could be suitable for you. Closed bridge loans usually have lower interest rates.
Open bridging loans do not have an agreed end date, but you will still need to discuss the time-frame of your repayment strategy with your lender. Even though they are open-ended, these normally don’t last for longer than two years.
If you need to borrow money over a more extended period, a bridging loan could end up being an expensive way to do so. Bridging loans are only intended to fill a gap in time before you secure a long-term solution, such as a mortgage, resale or secured loan.
Bridging Loan: Do I Need a Deposit?
Although there are a handful of lenders who will accept bridging loan applications with no deposit, they will require you to an excellent repayment plan, and their interest rates are likely to be very expensive.
Most lenders will require you to have a deposit of at least 25% and will be able to offer you better deals as your deposit increases.
Bridging Loan: How Much Can I Borrow?
How much you can borrow will depend on the value of your property and the strength of your repayment plan. The stronger your plan, the more you will be able to borrow.
Even with a watertight exit plan, most lenders will cap how much they are willing to lend you 80% of your ‘peak debt’. Your peak debt is the total debt you would have after buying the new property and before selling your old property.
Most lenders will also undervalue the property you want to sell by around 15%, to allow for any shortfalls.
For example, let’s imagine you have a solid repayment strategy and want to take out a bridging loan as you move from a £200,000 house to a £250, 000 house for which you have a 25% deposit.
The lender would first adjust the value of your current home by -15%, to allow for the possibility that you don’t sell at the asking price. With this adjustment, your current home is worth £170,000.
After taking your deposit into account, you would need to borrow £187,500 from the lender to afford the new property.
This means that your peak debt would be £357,000. If you have a solid repayment strategy in place, the lender could be willing to lend you up to 80% of this; meaning that on this occasion, you could borrow up to £285,000.
This is a simplified example of how lenders might calculate your borrowing limit. In reality, there may be many other considerations to take into account depending on your circumstances.
Bridging Loan: How Much Does It Cost?
When you take out a bridging loan, you will need to account for set-up fees (typically 2%) and interest, as well as any costs required to build a convincing repayment plan. Depending on your circumstances, this could include solicitors fees or paying an architect to draft plans, and could easily run into the thousands.
Interest rates on bridging loans are high compared to other property financing options. Interest is charged on a monthly basis, typically 0.5 – 1.5% per month, because bridge loans are designed for short-term borrowing. This is equivalent to an interest rate of 6.1 – 19.6% per year.
Bridging Loan: How Do I Repay?
You won’t be expected to repay your loan until your repayment strategy is in place. However, depending on the agreement you come to with your lender, you might need to make payments on interest during the term of the loan.
If you take out an interest-only loan, you will pay monthly instalments on the interest of your outstanding balance, meaning that you only need to pay back what you borrowed at the end of the loan when your repayment strategy comes through.
Alternatively, you can choose to ‘roll-up’ your interest and pay it all at the end. In this scenario, you don’t make any payments until your repayment strategy is in place. At this point, you are expected to pay back all of the capital you borrowed plus any accrued interest. Because of the large sums of money involved, this can quickly mount up.
If you have a ‘closed’ loan with an agreed end date, you can ask your lender to calculate the interest at the start of the loan term and include it in your final repayment.
Bridging Loan: What Happens if I Can’t Repay?
The most significant risk with a bridging loan is not able to repay what you borrowed at the end of the loan term. If you run into problems with your repayment strategy, you could find yourself in serious financial trouble.
Bridging loans are a form of secured borrowing, which means that your lender will ask you to offer assets, usually property, as security. If you don’t repay your loan, the lender can recover their losses by selling the property you offered as security.
For most people, the security they offer will be their home. If you own your home outright, the lender will put a ‘first charge’ on your home. This means that if you default, the lender has priority over other creditors to recover the cost of the loan and its interest from the sale of your home.
If you have a mortgage, the lender will order a ‘second charge’, which means that they have a priority to recover a debt after your mortgage provider.
Bridging Loan: What Kind of Property Can a Bridge Loan Be Used For?
t is possible to take out bridging finance for almost any kind of property, from dilapidated buildings to shiny new offices blocks.
However, you may find it more difficult to find competitive deals or lenders who are willing to lend on ‘high risk’ investments. This category includes properties with unusual characteristics (which could make them hard to resell) or whose repayment strategy is considered high-risk (such as undeveloped land).
Bridging Loans: Pros and Cons
|Buy Property without having to wait to sell your own home||It’s an expensive way to borrow thanks to monthly compound interest|
|Grab opportunities for investment when they arise||If your repayment strategy fails you could risk losing your investment or your home|
|Move home or invest even if dealing with a period of bad credit|
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