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Bridging LoansLewis Posner talks us through bridging loans and how they work.
What is a bridging loan and how do they work?
A bridging loan is essentially a short-term mortgage. When you’re looking at a normal mortgage, it’s usually fixed over a longer period of time. A bridging loan is designed to be exactly that – a bridge between two situations.
It’s usually short-term lending – typically less than 12 months, and the interest is different to a mortgage in terms of how it’s calculated and paid. Usually, the interest is added to the amount you’ve borrowed and charged on a monthly basis. You’re not having to pay it on a monthly basis, though, unlike a traditional mortgage.
Who can get a bridging loan and what can they be used for?
They’re essentially for everyone who needs short term secured borrowing. A common way they are used is when a property deal is falling through.
If you were, for example, buying a new property and the sale on your current home has stalled, you might still need to complete on the purchase even though you’ve lost your buyer. You could bridge to fill that gap until you’re able to sell your property.
We also see them used a lot in investment or development finance. Property investors will often buy properties at a discounted price to refurbish or redevelop, with the goal of making a profit. They can get a bridging loan to buy the new property, borrowing against properties that they already own. They then don’t have to apply for a mortgage on the purchase so they can secure the property more quickly.
What is the exit strategy?
The exit strategy is probably the whole key to a bridging loan because it’s a short term loan. So the main thing that the lender is underwriting is actually your ability to pay the money back.
You can get 12 month bridges and sometimes up to 18 months if you are an investor and it’s not secured against your primary residence. A longer loan needs to be secured against a Buy to Let or investment property.
The banks want to see a clear plan for how you will pay back the money. Because they’re rolling up the interest, banks don’t need to assess whether or not you can afford to make the interest payments – it’s all getting added to the principal loan.
They want to know how you’re going to pay the money back in 12 months when the bridge comes to an end. That is what you’d class as the exit strategy. It will depend on what the client’s circumstances are.
Refinance is a common one. If I’m buying a property and I’m going to do an extension or split it into two flats, for example, I might use a bridging loan to fund that work. When that project is complete, I would remortgage the finished property to raise the money to clear the bridging loan.
Or, using the example from before, if your buyer pulls out of the purchase and you need that money to buy your next house, the obvious exit strategy is the sale of your property. The exit strategy is the key bit that the bank wants to see.
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Some loans are first charge and some are second – what does this mean?
Usually, if you own a property and it has a standard mortgage on it, that lender has what’s known as ‘first charge’. In the event that you don’t pay your mortgage, the bank can get their money back by selling the property.
The first charge bank has a hold on the property to say you owe a certain amount of money. If you then want to borrow more money from a different bank against that property, on something like a bridging loan, that bank’s then going to have ‘second charge.’
If you don’t pay, somebody ahead of them is going to get their money back first. The second charge lender will get paid second in the event of the property being sold.
Second charge is therefore seen as higher risk for the bank, in case there’s not enough money when the property gets sold.
How long does it take to arrange a bridging loan?
It’s usually a quicker process because the underwriting is more focused on exit strategy rather than assessing the borrower’s capability to pay. A lot of the time it really comes down to valuation of the property and ensuring it’s suitable security to lend you money on.
If there’s a valid exit strategy, you can get a bridge through. It will take anywhere from four to six weeks from start to to completion.
What if I have bad credit – does this affect that bridging loan process?
Bad credit always has some impact. But for most lenders the real calculation is not on affordability. It’s not about your ability to pay the loan on a monthly basis.
So if you’ve defaulted or had payment problems in the past it’s not as much of a concern. What they really care about is the exit strategy. But bad credit can affect your exit – and that’s where there can sometimes be a problem.
Your exit strategy might be to refinance before the bridging term ends, getting a mortgage to pay back the bridging loan. If you’ve got poor credit you may not be able to get a suitable mortgage. So we need to make sure your exit strategy is solid – because you don’t want to get trapped.
What costs are involved with bridging loans?
It’s hard to judge costs, but I would say it’s typically more expensive than a traditional mortgage. With a traditional mortgage the bank’s earning their money over a longer period of time.
If you take a five year fixed rate mortgage, the bank knows it’s going to get paid a certain amount of interest over those years. Because a bridge is short term, a client might only hold that money for a few months – so the bank still needs to bake in enough profitability to warrant making that loan.
Typically, there is a higher arrangement fee, which is where a lot of the bank’s profit comes from. The interest rate is also going to be higher than a traditional mortgage – especially if the lender has a second charge on the bridging loan.
Usually the fees and interest get rolled up into the loan. So if you were to borrow £10,000 on a bridging loan with fees of £2,000, you would actually only receive a net loan of £8,000. The bank would factor that in. But in 12 months’ time you’re going to owe them £10,000.
So you’ve rolled the costs and everything up together rather than physically having to actually put your hand in your pocket to receive that money.
For a lot of people doing this as an investment, it’s just another cost of doing business. You would set out your development cost as X and the cost of finance as Y. It’s all factored into your profitability calculations.
How do you apply for a bridging loan?
Just give us a call – we’ll do the application for you. The biggest consideration, certainly if it’s for an investment project, is getting details around your existing property holdings. That’s usually something that a lot of people don’t always have to hand – particularly if you own quite a few properties.
What are the alternatives to a bridging loan?
A bridge is a very specific type of tool. You typically don’t want to use one unless you have to. It’s there as a short term plug for a gap.
If there is an alternative, that’s something we will always look at, but ultimately you tend to have a pretty pressing need if you’re using a bridge. We need to look at your situation in the first place and assess whether it’s the right tool for the job.
Your home may be repossessed if you do not keep up with your mortgage repayments.
Your home may be repossessed if you do not keep up repayments on a mortgage or other debt secured on it.