Bridging loans are short term (typically 12 to 18 months) secured loans, commonly used by property developers to aid cash flow. Unlike traditional loans where you repay an element of interest and capital each month, a bridging loan is repaid in full at the end of the term.
Aside from use by property developers to aid cash flow, other common uses of bridging loans include refurbishment and renovation (particularly on properties which perhaps would not qualify for a traditional mortgage in their current state), purchase of property at auction (where speed of funding is key) and purchase of property where the buyer is awaiting sale of their existing home (enabling a break in the chain).
Types of bridging loans
There are two types of bridging loans: open and closed.
Open bridging loans
With an open bridging loan, there is no fixed repayment date, meaning you can make the capital repayment whenever you have the funds to do so. It is also often possible to make partial repayments.
There is no fixed repayment date, but you are typically expected to pay back within six to twelve months before a penalty fee will become payable.
Whilst open bridging loans can be used where there is no clear exit strategy, the lender will have set lending criteria and will need to get comfortable that you will repay the loan. This, paired with the fact that lenders have less visibility over the timing of cash receipt means that open bridging loans are regarded as higher risk and generally come with a higher associated interest rate.
Closed bridging loans
A closed bridging loan differs in that the loan agreement will specify a fixed repayment date and the lender will require a clear exit strategy (i.e. a plan outlining how you will generate the funds to repay the loan). A common exit strategy would be sale or remortgage to a longer term lower rate facility once renovations are complete.
Repayment methods don’t have to be linked to the property you require the bridging loan for though. For example, if you are expecting a receipt of cash from a separate business interest, this could be used as your exit strategy.
Closed bridging loans are generally regarded as lower risk than open bridging loans due to this defined exit strategy and set repayment date. As such, they typically offer lower interest rates.
What security does a bridging loan provider require?
The security required will vary by lender. Some lenders will require a first charge security (i.e. where the bridge loan provider would be first in line for proceeds if the underlying property had to be sold to repay the outstanding debt), whilst others will also consider accepting a second charge at their discretion (i.e. where the bridge loan provider would be second in line to another lender which holds the first charge).
Lenders typically seek a maximum loan to value ratio of 80% on residential properties and 65% on commercial properties.
As always, lenders price loans based on the risk they perceive in lending based on the security taken. As such, a higher LTV and second charge would result in a higher interest payment than a lower LTV and first charge.
What costs are involved in obtaining a bridging loan?
As well as interest on the outstanding loan (which can be both fixed or variable), lenders typically charge an arrangement fee. Other fees may include legal fees, security fees, valuation fees, broker fees, early repayment fees or penalty fees.
You should take care to read the bridging loan documentation with a fine toothcomb to understand the full cost of lending.
Example of bridging loan financials
Let’s imagine that you find a property at auction, which you can secure for £600k. The property has some structural damage and thus is not eligible for a standard property mortgage. Once redeveloped, the building could be worth £580k.
You have £100k in cash and therefore need to borrow £300k via a bridging loan. The lender is charging a monthly interest rate of 0.7% and there are one off fees of £3k. If you borrowed on these terms for 12 months, the total repayment would be £321k (£18k interest plus £3k one off fees).
If the work is done and the property sold within the 12 month period enabling repayment of the loan, profit of £59k will have been made (£580k sale price less £400k purchase price, £100k expenses and £21k interest and fees).
Clearly this example is oversimplifying and does not consider fees such as the cost of selling. However it does illustrate how bridging loans are commonly used by property developers to aid cash flow and increase profitability.
How quickly can a bridging loan be agreed?
One of the key selling points of bridging loans is how quickly they can be agreed and funds received.
You can typically find out if your application has been approved, subject to valuation and lender checks, within 24-48 hours. At this stage you will have agreed the credit and terms in principle.
Within the next two weeks, the lender will seek to confirm the valuation of the property and will finalise their security and identification checks prior to the funds being released.
Bridging loans vs. traditional property loans
We have touched on some of the differences between bridging loans and traditional property loans above. However, in summary, there are three key differences: (1) higher risk and therefore interest rates, (2) speed of funding process, and (3) duration of loan term.
Bridging loans are provided as a means of short-term financing. It is quite common to lend against properties which do not meet traditional lending criteria. For example, where extensive redevelopment is required.
Further, in order to serve their customers needs, bridging loan providers typically offer faster application and approval processes. This increased risk and increased speed of funding comes at a price.
