By Gary Hemming, ABC Finance
What is a bridging loan?
Bridging loans, also known as bridging finance is a type of loan which is secured against property, much like a mortgage.
The key difference is that bridging loans are usually designed to cover a short-term need, whereas mortgages are longer term.
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Due to a simplified application process, bridging loans can be arranged quickly, often in 5-10 days. This is far quicker than the average property-backed loan, with traditional mortgages usually taking around 6 weeks to complete.
There is a price to pay for the speed and convenience with interest rates and fees usually coming in higher than with mortgages.
Bridging Loan Uses
Bridging finance can be used for almost any purpose, although there some common uses, such as:
- To complete a purchase quickly (such as a property purchased at auction)
- Funding the refurbishment of a property
- To fund the forward purchase of a property before your current home is sold
- To purchase a property below market value
- Completing a purchase on an otherwise unmortgageable property
How Bridging Loan Applications Are Assessed
There are a few key factors in the assessment of bridging loan applications, the main ones are:
- The ‘exit strategy’
- The’ loan to value’
- The applicant’s credit history
- Experience of the borrower
The interest charged on a bridging loan is often rolled into the loan and paid on redemption of the loan. As such, strict affordability calculations aren’t needed in most cases.
The key to most bridging loan applications is how the loan will be repaid at the end of the term. The method of repayment is usually referred to as the ‘exit strategy’. Common exit strategies are for the property to be refinanced onto a traditional mortgage, or sale of the property.
Where the property in question is being sold, the lender will be keen to ensure the term offered is sufficient for the property to sell.
Where the exit strategy is through refinancing the loan to a mortgage, the lender will be keen to see proof that this is possible. Usually, a decision in principle from the new lender is accepted.
The ‘loan to value’ of the proposed loan is crucial to most applications, with rates increasing as the LTV increases. A higher loan to value increases the risk to the lender in the event of default, as such, lower LTV applications tend to see a simpler application process and a higher chance of success.
Although the monthly payments are usually added to the loan, most lenders will still pay attention to the applicant’s credit history. This is because there is still a chance of default through failure to repay the loan at the end of the term.
It’s still possible to get a bridging loan almost regardless of your credit history, you may be ineligible for some of the lower rate products.
Finally, experience can be a key factor for some lenders, especially where conversion or refurbishment work is to take place. Again, a lack of experience doesn’t mean you will be unable to secure bridging finance, it can limit the number of lenders that are willing to lend.
Bridging Loan Costs
Bridging loan rates are lower than ever, with rates for residential properties currently starting at 0.43% per month. This rate is only available up to 50% loan to value, with rates at 75% coming in from 0.64% per month.
Rates for commercial and semi-commercial bridging loans tend to be higher, with rates starting from 0.65%. Again, these rates are only available for LTV applications, with rates at 70% LTV starting from 0.84%.
Although low headline rates are available, they are for lower risk applications only, with rates of 1% common.
In addition to the interest charged, lenders will usually charge an arrangement fee – usually 2% of the loan amount. The lender arrangement fee can be higher, as much as 3% with some lenders and may reduce as low as 1% for low-risk, larger loans. Lender arrangement fees can usually be added to the loan.
Where a broker is used, some will charge a fee for their services, often as much as 1.5% of the loan amount. There are fee-free brokers out there, so choosing one of them can represent a considerable cost saving. Broker fees are also usually added to the loan.
4 Things To Consider Before Taking Out A Bridging Loan
The total cost of borrowing
Rather than chasing the lowest possible interest rate, consider the total cost of the loan before proceeding. Some lenders will charge additional fees, which can increase the total cost of borrowing, meaning a higher rate loan may actually be cheaper.
Other fees, such as broker fees can significantly add to the cost of borrowing, so always ask for and compare the total cost of borrowing where possible.
Am I getting the best deal?
The best deal isn’t always the cheapest deal. By talking to your lender or broker, you should aim to understand other factors associated with the loan. Always ask how quickly the lender will be able to complete the application and try to find out if the lender charges default interest rates if you’re unable to repay on time.
Remember, you’re looking for the cheapest loan that fits your purpose, not just the cheapest product. If the loan can’t be completed as quickly as you need it, it may not be of any use to you.
How the loan will be repaid
As mentioned earlier, lenders will be keen to know how the loan is to be repaid. This should also be your number one concern, if your exit strategy is far from guaranteed, you’re taking a big risk.
As with other types of secured borrowing, if you default on the loan, you’re risking repossession of the property. This risk can be dramatically reduced by considering your exit strategy carefully before you begin your application.
Is a bridging loan the most suitable product?
Bridging loans can be expensive, but invaluable in the right circumstances. Before committing time and money to finding the best bridging loan for you, consider whether there are other options available.
For lighter refurbishment projects or fast purchases, there may be mortgage lenders who are suitable. In this situation, you could open yourself up to big savings by going straight to a ‘term loan’.