What is a bridging loan?

Last updated: May 2024 | 3 min read

Bridging loans are short-term financing solutions that provide funds to bridge the gap between purchasing a new property and selling an existing one. They offer flexibility and enable buyers to seize time-sensitive opportunities.

With a rising demand in residential property and multiple lender options, the UK's bridging loan market has experienced substantial growth in recent years. On your home-buying journey, this loan can offer just the solution you are looking for. This article explains how bridging loans simplify complex property transitions.

How does a bridging loan work?

A bridging loan offers short-term financing for individuals or businesses during a gap between two financial transactions.

Often, these loans are a popular choice in real estate dealings, providing funds to purchase a property before selling an existing one.

Characterised by their temporary nature, bridging loans fill the financial void.

These loans can be usually secured against real estate assets.

Key features

Bridging loans have attributes that differentiate them from other financial products.

Key features include their short loan term, usually ranging from a few weeks to 12 months, but this may vary.

A clear exit strategy – a defined plan for repaying the loan, constitutes a bridging loan.

Interest rates for bridging loans tend to be higher compared to traditional loans. This is because of the increased risk and short-term nature.

Lenders usually offer two types of bridging loans: open and closed. Open bridging loans do not have a fixed repayment date, offering more flexibility, whereas closed bridging loans come with a predetermined repayment date, often aligned with the sale of a property.

Pros and cons of bridging loans

Pros

  • Property investors often turn to bridging loans for swift financial solutions. In the competitive realm of property investment, speed can be as important as the investment itself. The ability to act swiftly, especially at auctions, is advantageous.

  • Bridging loans allow investors to purchase new properties before their existing ones are sold. This capability ensures they don't miss out on valuable opportunities.

  • Bridging loans work by offering short-term funding, typically from 3 to 24 months. Property investors find this flexibility aligns perfectly with the dynamic nature of the property market.

  • Bridging loans can be used to finance renovations or developments, enhancing a property's value before a sale or longer-term financing solution.

Cons

  • Despite their benefits, these loans are not without risks. Bridging loans interest rates are higher than for traditional mortgages. (Learn all about the types of mortgages available in the UK.)

  • A very carefully planned exit strategy is required to avoid financial strain. The sale of the current property or securing a long-term mortgage are common exit strategies.

  • Hefty charges and property repossession in case of failure to pay the loan, are two of the major downsides.

Using bridging loans for buying before selling

Individuals often face the dilemma of finding their dream home before selling their current property. In such situations, bridging loans can be a practical solution.

These loans are usually secured against the existing property. Once the current home is sold, the proceeds can repay the bridging loan. This setup allows buyers to move into their new home without the pressure of immediately selling their old one. Read our detailed article about the costs of buying and moving into your new home.

However, there are factors to consider before choosing this option. Bridging loans not only have higher interest rates but there are additional costs like arrangement fees, legal fees, and valuation fees.

Buyers must also be aware of the loan-to-value (LTV) ratio, which determines how much can be borrowed against the property's value. A higher LTV ratio means more debt secured against the property, increasing the financial risk. Before making a decision, consult about the maximum loan to value limit.

Buyers should consider the total cost of the loan and not just the interest rate. They must have a clear plan for repaying the loan, usually from the sale of the existing property or obtaining a mortgage.

Without a solid exit strategy, buyers could face financial challenges, including struggling with monthly interest payments or even risking property repossession.

The use of bridging loans in these scenarios highlights the need for careful financial planning and an understanding of the risks involved. While they offer a convenient way to manage property purchases, the costs and possible pitfalls require thoughtful consideration.

The mechanics and uses of bridging loans

A key feature of bridging loans is the way they're secured. Normally, these loans are secured against property. This means borrowers must own a property that can act as collateral.

A bridging loan can be a valuable tool when you need quick financing under time-sensitive conditions.

A regulated bridging loan comes into play when borrowing funds by using a property as collateral, provided that this property is currently inhabited or will be inhabited by the borrower themselves or their immediate family members. But if the intended occupants are not directly related to the borrower, a Buy to Let loan or a traditional mortgage would likely be a more appropriate financing option than a regulated bridging loan. The primary differentiator lies in the usage of the property. Regulated bridging loans are specifically meant for properties serving as the principal residence for the borrower or their close relatives, while other loan types cater to investment properties or rental units.

Some people might use them for paying tax liabilities.

Another possible use of this type of loan is for a Buy to Let property purchase. Unregulated bridging loans cater to business purposes in property development. These loans are for developers who acquire properties with the intent of renovating, refurbishing, or preparing them for resale or rental purposes. An unregulated bridging loan can support a client in finding funds quickly and capitalising on a good investment opportunity.

Commercial bridging loans serve as temporary financing solutions for businesses facing gaps in their cash flow. These loans bridge the interval between a payment obligation and the availability of another funding source to fulfil that payment. Commercial mortgage development finance can help those who want to develop land from the ground up or completely redo an existing property.

Loan types, terms, and repayment

In bridging finance, the repayment date is a central component. This date sets the timeline by which borrowers must repay the loan in full. Understand this feature thoroughly, since it affects the entire borrowing process.

Closed bridging loans

The choice between an open or closed bridging loan largely influences this repayment structure. Closed bridging loans with their pre-determined end date, usually aligned with known future income, like the sale of a property, offer a sense of security for both borrower and lender. The repayment plan is clear from the start.

Closed bridging loans are used when you know exactly when you'll have the funds to repay the loan. This certainty comes from a specific, confirmed financial event, like the sale of your existing property, set to conclude on a known date.

Closed bridging loans often have lower interest rates compared to open loans, reflecting the reduced risk associated with a clearly defined repayment plan.

Open bridging loans

Open bridging loans without a fixed repayment date provide more flexibility, but this comes with higher risk due to the uncertainty of repayment.

This type of loan suits you if you're unsure when you can repay the loan. For instance, if you're selling a property, and haven't yet found a buyer, an open bridging loan can provide the necessary funds while giving you flexibility on repayment. The lender will still require a clear exit strategy, detailing how you plan to pay back the loan.

Grasping these terms and how they align with your financial situation and objectives are important for effectively utilising bridging finance.

First charge vs second charge bridging loans

When you borrow money using a bridging loan, the lender secures the loan against a property. If the loan is the only or primary borrowing secured against the property, it's a first-charge bridging loan.

First-charge loans generally offer more favourable interest rates due to their primary claim on any repayment proceeds.

If you fail to repay the loan and your property is sold to pay the debt, the bridging loan lender would take this amount.

Second-charge loans come into play when there's already a mortgage or another loan secured against the property. In these cases, the second charge loan only gets repaid after the first charge is cleared.

Due to the increased risk for lenders, second-charge loans have higher interest rates than first-charge loans.

If you have an existing mortgage and are considering a bridging loan for additional finance, then you must be aware of these aspects.

Types of interest on bridging loans

Interest rates on bridging loans can be either fixed or variable.

Fixed-rate

Fixed-rate bridging loans guarantee the interest rate stays constant throughout the loan term. This predictability in monthly repayments appeals to those who value stability in their financial planning, particularly in a fluctuating market.

Variable rate

Variable rate bridging loans have interest rates that can change, usually in line with the Bank of England's base rate or other market indicators. While offering lower initial rates, they carry the risk of increasing costs should interest rates rise.

Weighing these options depends on your risk tolerance and financial circumstances. Variable rate loans might suit you if you expect a short loan duration or anticipate falling interest rates.

Eligibility and application process

What do lenders look for?

To qualify for a bridging loan means passing the lender's evaluation criteria. They may have several criteria to determine eligibility.

  • They focus on the value and type of property you’re securing against the loan. Normally, both residential and commercial properties are acceptable.

  • How much equity you have in the property also plays a part in the decision-making process.

  • Your credit history isn't always a primary concern, but it's still considered. For borrowers with bad credit, some lenders might still provide a bridging loan, though possibly at a higher interest rate. Read our helpful tips on how to improve your credit score.

  • Your exit strategy, how you plan to repay the loan, is a component that lenders scrutinise. A strong, plausible exit strategy could be the sale of the property or refinancing with a longer-term financial solution.

Step-by-step guide for securing a bridging loan

  1. Assess your need: determine why you need the loan and how it fits into your larger financial plan. This self-assessment guides you in deciding the type and terms of the loan.

  2. Find a lender or broker: you can approach lenders directly or use a specialist broker. Brokers can compare bridging loans across the market, finding better rates or terms based on your situation.

  3. Apply: the application will require details about the property, the loan amount, your exit strategy, and personal financial information. Be precise and honest in your application to avoid any delays.

  4. Valuation: the lender will arrange for a valuation of your property. This valuation fee, often upfront, varies based on the property and lender.

  5. Receive an offer: if the lender approves your application, they'll issue a formal offer. Review this carefully with regard to interest rates, fees, and loan terms.

  6. Legal checks and paperwork: legal processes follow, including checks and contract preparations, usually involving solicitors. Here's more detail about how to find a good solicitor.

  7. Funding: once everything is signed and all parties agree, the loan is released.

  8. Repayment: stick to your exit strategy for repayment, mindful of any changes in your circumstances that might affect your ability to pay back the loan.

Getting a bridging loan may seem complex, but with clarity about your needs and a reliable repayment plan, it's a manageable and often speedy process.

Costs and fees of a bridging loan

So how much does a bridging loan cost? They tend to be very expensive. Their term is short compared to other types of loan so you should plan meticulously.

Interest rates

Bridging loan interest rates differ from those of more conventional loans. Lenders charge monthly interest rates for bridging loans, unlike the annual rates common in standard mortgages or personal loans.

The reason lies in the short-term nature of bridging loans, designed to bridge the gap in financing for a brief period. Consequently, when considering a bridging loan, focusing on the monthly interest rate becomes key.

As mentioned above, bridging loan rates might be higher, reflecting their higher risk and shorter duration and they can be either fixed or open. Given the monthly charging structure of bridging loans, even slight variations in interest rates can significantly influence the overall cost. For instance, a 1% monthly interest rate translates to an annual percentage rate (APR) of 12.7% when compounding is factored in. A 2% monthly rate escalates the APR to a substantial 26.8%.

You, as a borrower, need to understand how these rates apply to your loan amount and how they impact your total repayment sum.

Additional fees

In addition to interest rates, bridging loans come with various fees that can impact the overall cost. Calculate them beforehand, so there are no surprises in your financial planning. Here are some of the common additional charges:

Valuation Fees

Bridging loan lenders often require a professional valuation of the property used as collateral. This valuation fee varies based on the property's size and value. It's a one-off cost that appraises the property's worth, assuring lenders of the asset backing their loan. Read more about mortgage valuation.

Administrative/ repayment fee

This is yet another cost for you to be mindful of when applying for a bridging loan. It involves the process of your application evaluation and determination of your repayment structure.

Legal Fees

Legal fees in bridging loans cover the cost of the lender's and sometimes the borrower's solicitor. These fees ensure that all legal aspects of the loan are properly managed, safeguarding both parties' interests.

Broker Fees

If you use a bridging loan broker, they typically charge a fee for their services. Bridging loan brokers can provide valuable advice and help find competitive rates, but their services add to the overall cost of the loan.

Early exit fee

In case, you want to exit early, it may incur an additional fee.

Each of these fees adds to the total cost of borrowing, influencing the affordability of the loan.

Risks and benefits of bridging loans

When is a bridging loan a good idea?

Bridging loans are suitable when quick funds are needed, like in home purchases before an existing property sale. They're ideal for buying at property auctions, requiring fast payments. Their suitability, however, is contingent on having a plan for swift loan repayment, generally within 12 months.

Possible risks and how to mitigate them

High interest rates and fees make bridging loans pricey. A sound exit strategy mitigates risks. Comparing offers on property and realistic property valuations is key.

Also, understanding market conditions helps gauge if the timing is right for such a loan. Always base your decision on financial stability and a clear plan.

Alternatives to a bridging loan

While bridging loans are designed for short-term financing needs, they are not the only available option. Some alternatives to consider include:

Secured Loans

These allow borrowing larger amounts than personal loans and typically charge lower interest rates than bridging loans. However, like bridging loans, secured loans are backed by your property, putting your home at risk if repayments are not made.

Personal loans

Some lenders offer personal loans up to £50,000, with £25,000 being a more common limit. These unsecured loans could be an alternative for relatively small bridging loan requirements. Interest is charged annually rather than monthly, making repayments more affordable. Since they are unsecured, your home is not at risk of repossession.

These may be long-term or small loans:

Long-term loans: for larger borrowing needs, long-term loans offer lower monthly repayments by spreading the repayment over an extended period.

Small loans: if the required amount is modest, considering a small loan with a shorter repayment period could be an option for you.

FAQs

How much can I borrow with a bridging loan?

Bridging loan amounts range widely, from £5,000 to £25 million or higher, depending on your financial situation and credit profile.

Mostly, lenders permit borrowing up to 75% of the property's value.

They tend to offer higher loan amounts for first charge bridging loans compared to second-charge loans, where the lender has a subordinate claim on the property.

Can you secure a bridging loan with bad credit?

Yes. Bridging loans often offer a lifeline when traditional funding options falter, especially for those with less-than-perfect credit histories. Lenders normally focus more on the value and potential saleability of the property used as security, rather than solely on credit scores. Securing a bridging loan with bad credit is possible.

Nevertheless, bad credit can influence the loan's terms. It often results in higher interest rates and additional security may be required.

How long does the bridging loan process take?

The timeline for obtaining a bridging loan can be impressively swift, particularly compared to traditional loans. Often, the process from application to receiving funds spans just a few weeks, sometimes even less.

The exact timeframe depends on factors like the loan amount, property type, and borrower's circumstances. Swift processing is a hallmark of bridging loans, making them ideal for urgent financial needs in property transactions.

Delays can occur, usually due to legal or property valuation issues, so it's wise to prepare all necessary documentation in advance.

What will the impact of a bridging loan on my credit score?

Bridging loans, like any form of borrowing, can affect your credit score both positively and negatively.

Missed payments or defaulting on the loan can harm your credit score. As bridging loans are typically short-term with high stakes, precise planning for the loan's exit strategy can mitigate this.

Responsible management of the loan, timely interest payments, and repaying the capital by the agreed date can positively influence your credit history.

A well-managed bridging loan reflects positively on your credit report, demonstrating reliability to future lenders.

How can I find the best bridging loan?

The loan which suits your particular circumstances and property transaction requirements will be the best one for you. You need to do your research. Forbes offers some options along with their reasons for picking some of the best bridging loans in the UK.

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