A bridging loan provides you with short-term finance when you’re purchasing a property. As its name suggests, it bridges the gap when you’re ready to make the purchase but are waiting to secure alternative finance, such as a mortgage or the proceeds from the sale of another property. This secured loan has a high rate of interest but you receive funds quickly and benefit from flexible borrowing arrangements.
What are bridging loans used for?
A bridging loan is generally used when you need funds to buy a property while waiting for an alternative source of funding to become available. For example, you may have found a new home but are still waiting to find a buyer for your existing home. Alternatively, you may be purchasing a property at auction and are in the process of securing a mortgage. As auctions have a short completion timescale, you need to ensure you already have the funds in place.
You might have found a property requiring renovation work and are unable to get a mortgage until it’s considered habitable. In this case, the bridging loan allows you to complete the work and switch to a mortgage when the property meets the required standards. Another example is when you’re in a chain that has collapsed and a bridging loan is used to hold part of it together.
Types of bridging loans
A bridging loan is tailored to your specific needs and circumstances. It is a secured loan, meaning that you must have a high-value asset as security, such as your current home. It’s important to choose the right type of bridging loan and we’ve detailed the different options to consider below.
An open or closed bridging loan
A closed bridging loan is when you have a clear exit strategy. From the outset, you confirm to the lender how the loan is to be repaid at the end of the term. This type of loan has a fixed end date and usually only lasts up to a few months. An example of this is when you have a sale going through on your property and know the completion date.
With an open bridging loan, there’s no end date to repay the loan. It usually lasts for up to a year and tends to be the more expensive option due to its flexibility. Your exit strategy in this case could be, for example, settling the loan with the sale of a property that’s not on the market yet. Alternatively, you may have invested in a property with the intention of renovating it and selling it. The proceeds from the sale would then repay the open bridging loan.
Fixed or variable rate
You can choose between having a fixed or variable rate, just as you would with a mortgage. If you prefer stability with your payments, a fixed rate provides you with a set interest rate throughout the loan term. A variable rate, on the other hand, changes depending on the lender’s rate, which is often linked to the Bank of England’s base rate. This means the interest can go up and down but you’ll benefit at a time when the market is favourable.
First charge or second charge loan
A ‘charge’ is applied by the lender when you apply for bridging finance. This denotes where the priority lies when collecting payment if you’re unable to settle the debt at the end of the loan term. If your property is repossessed and sold, the first charge loan is settled first, followed by the second charge loan.
To explain, a first charge loan is the first one to be secured against your property. When you have a mortgage, this is your first charge loan so a bridging loan becomes a second charge loan. If you don’t have a mortgage or other outstanding loan on the property, a bridging loan is counted as a first charge loan. In the case of repossession of a mortgaged property, the mortgage would be settled before the bridging loan.
What costs are involved?
Bridging loans are a convenient way to get a large sum of money quickly with flexible borrowing options. However, as well as being secured against your property, there are high costs involved to benefit from having one.
The interest rates tend to be high and are usually calculated on a monthly basis. As a bridging loan is for such a short term, there are different options to repay the interest:
- Monthly: The interest is paid monthly and isn’t added to the balance of your bridging loan.
- Rolled up: The compound interest is paid at the end of the term with the loan amount.
- Retained: Your lender ‘retains’ the monthly interest until an agreed date when you repay it in full.
Your lender may let you combine two of these options, such as starting with retained interest and then paying monthly interest.
As well as the interest, there are various fees to take into account. These can include:
- An arrangement fee: This is for setting up the loan and is usually about 1 to 2% of the loan amount.
- Valuation fees: These pay the costs for a surveyor to value the property used as security for the lender. A valuation is required by the lender to determine whether they agree to the loan.
- An administration/repayment fee: This covers the administration costs, such as the paperwork.
- An exit fee: If you repay the bridging loan early, the lender may charge you an exit fee. This can be about 1% of the loan amount.
- Legal fees: This covers the legal fees charged by the lender’s solicitor for handling the agreement.
- A broker’s fee: To get a competitive bridging loan with the best rates, it’s recommended to use the services of a broker. Although this is another fee, a broker’s expertise can save you a lot of money across the term of your bridging loan.
What are the alternatives to a bridging loan?
With a fast application process and the ability to borrow a large sum of money with flexible borrowing options, a bridging loan has lots of benefits. There are other options to consider, though, if you’re not completely sure that a bridging loan is right for you.
- Remortgaging your property frees up some of your equity, providing you with a lump sum. The application process is lengthy compared with a bridging loan. The loan is on a long-term basis, such as 25 years, and is a much cheaper way to borrow money than taking out a bridging loan.
- A let-to-buy mortgage is an option if your current property sale falls through while you’re buying another property. This lets you purchase and move into the new property while you rent out your current property to tenants.
- When developing or refurbishing a property, a development loan is designed to help with the purchase and build costs. It’s a short-term loan that’s usually between 6 and 18 months.
As with any type of finance, speak with a broker to find out the best options available to suit your needs and circumstances.