Bridging loans, also known as bridging finance is an often misunderstood form of finance that is used strategically by many property professionals and well-informed homeowners. Most homeowners don’t consider using them, often because they don’t know when they should be used or how they could benefit. In this guide, we will break down what a bridging loan is, how they work, their cost and when they should be considered.
What is a bridging loan?
Bridging loans are a type of short-term loan which is secured against your home (or another property) and are used to ‘bridge a gap’ between two events taking place. Usually arranged over a term of 1-18 months, they’re designed to be flexible and quick to arrange.
There is a common miss-conception that they’re expensive and that the lenders are ‘loan sharks’, this couldn’t be further from the truth! In fact, if the loan is secured against your home, the loan is protected by the Financial Conduct Authority (FCA), much like a standard mortgage. Bridging loans are offered by some banks, and some bridging lenders are actually funded by banks, so with interest rates currently starting at just above 5%, they are an attractive option.
Common uses of short-term finance include bridging the gap when buying a property before yours has sold, raising capital quickly or to complete an urgent property purchase while waiting for a mortgage application to complete.
How do bridging loans work?
The flexibility continues in the application process, which is very straightforward compared to the mortgage process. Lenders tend to focus on the value of the property and how you will repay the loan. Due to the streamlined application process, the process can be completed quickly, with most loans moving from application to completion in 7-21 days.
Another major difference between bridging loans and mortgages is in how the interest is handled. Most bridging loans have no monthly payments, instead, interest is added to the loan, and repaid at the end, when the loan is redeemed.
They can be arranged on a 1st charge basis like a mortgage, or as a 2nd charge sitting behind your current mortgage. There are generally no penalties for early repayment, and if you come to the end of the term and aren’t able to repay, the lender may look to simply extend the loan.
When the property is sold or refinanced, the bridging loan is repaid.
How much do bridging loans cost?
Bridging loan interest rates are quoted on a monthly basis, rather than annually and currently start at 0.43% per month. Most loans come with interest rates between 0.43-0.75% per month or 5.16-9% annually.
On top of the monthly interest rate, there are other setup costs to consider, they are:
- Lender arrangement fees – Bridging loan lenders charge a fee for setting up the loan.Yyou can usually expect to pay 2-2.5% of the loan amount, with this reducing in some cases for larger applications. This fee can usually be added to the loan.
- Valuation fees – Valuation fees are due in some cases, with some lenders accepting computer-generated valuations for lower loan to value applications. Where a physical report is required, valuation fees are paid at the beginning of the process.
- Legal costs – Also known as solicitors fees, your legal costs will be payable partway through the application process.
- Broker fees – Some brokers charge fees for their service, with some charging as much as 1.5% of the loan amount, although not all brokers charge a fee.
5 essential tips when taking out a bridging loan
When considering taking out a bridging loan, follow these 5 tips to make sure you get the best deal:
- When using a broker, opt for a fee-free broker as high broker fees can dramatically increase the cost of your loan.
- Always compare options from multiple lenders. The rates charged by different lenders vary wildly, so always speak to more than one lender, or use an experienced fee-free broker.
- To access the lowest rates, consider reducing your loan to value as this is a key driver of bridging loan pricing.
- Always consider your exit strategy before taking out bridging finance and make sure you have a backup plan in place.
- Check your lender’s default charges. Some lenders charge high default fees in the event of late payments, while others don’t, so always check for high default charges when comparing 2 lenders.
