What is a bridging loan?
It’s a package of financial support which is used to quite literally ‘bridge’ the gap between what you have, and what you need – usually on a very short-term basis.
It’s a secured loan which might be taken out while waiting for a major business development like another injection of funding, cash from a property sale – or in the event of an unforeseen emergency.
For example, you might be in the process of selling an asset, and want to buy another one before the deal is done to avoid missing out. In an instance like this, a bridging loan can be a perfect stop-gap.
What else might it be used for?
You can use a bridging loan to fund a new business venture, pay an outstanding tax bill, or bankroll a property purchase or refurbishment.
You can also use it to fund or refinance a property deal, including taking on an uninhabitable property, or one which is not deemed mortgageable by traditional lenders.
Or you could use it to pay for a property purchase while you are waiting for the planning permission required to begin a lucrative development.
Pensioners either looking to downsize or arrange payment for care home fees might use bridging loans too, if they are waiting to sell their current home.
How do bridging loans work?
They are designed to cater for clients who typically need the money for a period of between one month and two years.
Interest is charged monthly, in much the same way as a typical mortgage. But the advantage of a bridging loan is that it’s much more flexible than a mortgage.
For example, if you take what’s known as a ‘closed bridge loan’, interest can be added to the amount borrowed, with a fixed repayment target date.
Almost all lenders require the applicant to be at least 18 years old.
Open or closed – what’s best for me?
Open bridging loans don’t have a fixed repayment date, which means your monthly interest payments can’t be deducted from the amount owed. That means extra flexibility, but also more uncertainty.
By contrast, with a closed bridging loan it is much easier to keep track of the total interest cost and subtract in up front, because the deal is arranged over an agreed set timescale.
Some people use what is known as ‘retained interest’ – this is where the lender takes all the interest up front, out of your loan balance.
There are pros and cons for each variant, and as in any case when you are borrowing money, it’s important to carefully research your options.
Open bridging loans tend to be more expensive, and you will also have to provide proof that you can keep up with the monthly interest payments.
This makes the underwriting process more complicated and time-consuming, and means that open bridging loans can take longer to be set up.
If you’re looking for the lowest risk option, that will be a closed bridging loan – with no monthly repayments.
But before making your choice, we’d always recommend talking to an expert who can compare the various options and set them against your particular circumstances before suggesting the best course of action.
Whichever route you choose, though, you should only take out a bridging loan if you’re confident and clear in your mind about exactly how and when you want to pay it back.
What sort of interest rates will I pay?
That’s hard to answer, as it fluctuates much like the domestic mortgage market, with either fixed rate or variable rate choices.
One major difference with a bridging loan, however, is that you won’t find the rates advertised on any mass marketing material. It will be decided once you have outlined your specific needs and circumstances, and explained the type of property you want to secure the loan against.
Because it’s a short-term finance deal, interest charges will be higher than a standard mortgage, and can also differ widely from one lender to the next.
But as these loans are only in place for a matter of months, the risk of large swings in your monthly interest rate are low. Choosing a fixed rate will give you the greatest certainty.
Just like domestic mortgages, the lower the loan-to-value (LTV), the more competitive the interest rate will be.
You might want to increase the deposit you’re paying to reduce the loan to value, or offer additional security to the lender to see if it will persuade them to give you a more favourable deal.
Make sure you’re clear about whether it’s a fixed or variable rate loan being offered before signing on the dotted line.
Not all bridging loans are regulated, although some do fall under the auspices of the Financial Conduct Authority – typically where borrowing is secured against your own home.
If you’re using the proceeds of the loan as a second charge for business purposes, or to buy an investment property, it won’t be regulated.
Whenever you take out bridging finance, a charge will be placed on your property, which means the lender must be repaid - and gives them legal rights to act if you default on repayment.
If you don’t have a mortgage on your property, then your bridging loan will be what’s known as a ‘first charge’ loan.
If you do have a mortgage which will remain in place alongside your new borrowing, it will be deemed a ‘second charge’ bridging loan.
If you default on your repayments, priority goes to a first charge lender. This is why second charge bridging loans tend to cost a little bit more.
If in doubt, talk to the experts.
Can I repay my bridging loan early?
Yes, and if you do, interest will only usually be charged for the time that the funded were borrowed.
Some lenders do charge an additional ‘exit fee’ when the loan is repaid, which can be up to 2% of the loan amount. Check the small print.
There are a number of other fees that you need to be aware of, however, whether you repay your loan early or not. These include:
- VALUATION FEE: Usually covering a basic survey of the property, but if significant refurbishment works are planned, the lender may insist on a more detailed report. Some lenders do offer automated valuations at no charge – so make sure to ask
- ARRANGEMENT FEE: Typically between 1-3% of the loan amount, which can be added to the overall cost of the loan to be repaid
- LEGAL FEES: You will usually be expected to pay the lender’s legal fees as well as your own
- BROKER FEES: If brokers are proposing to charge a fee for their services, this should be disclosed up front. Not all do
Pros and cons
If you’re considering applying for a bridging loan, it’s important to weigh up the advantages and disadvantages.
Advantages include:
- If you are using the cash to buy or renovate properties, the profits can far exceed the cost of taking out the loan
- If you’re stuck in a property chain, they can stop you losing out on a property
- They can help you to buy a property which is not deemed mortgageable in its current condition by traditional lenders
Disadvantages include:
- Interest rates will be higher than for domestic mortgages
Things to consider
As you near the end of your term, you MUST make sure you have funds in place to repay your loan.
If you’re going to do this through refinancing, make sure your new lender is happy to lend in principle – and have a back-up plan, just in case.