Bridging loans are short term interest-only loans that you can take out so you can buy a new property before you’ve sold your existing one. They can also be useful in some limited circumstances but they are not cheap.
Uses of bridging loans
The best known use of bridging loans is where you’ve not been able to sell your home quickly enough to buy your new property. Bridging loans can also be used if you’re buying a property at auction or if you’re doing up a dilapidated property that an ordinary mortgage lender wouldn’t look at.
Types of bridging loans
There are two types of bridging loan:
1. A ‘closed’ bridge: this is a bridging loan where there’s a guaranteed exit in place, because long term funding has already been arranged. However, because property sales and mortgages can fall through at the last minute these are far less common.
2. An ‘open’ bridge: this loan is used where there isn’t a definite exit date for the lender because long term finance isn’t in place. It normally runs for a specific period, such as six or nine months, but it can be longer.
SAVVY TIP: If you take out an open bridge you can opt to make the interest payments as you go along or to pay the interest when you repay the whole loan, which is called ‘retaining the interest’.
How bridging loans work
Some high street lenders offer bridging finance and there are several specialist bridging loan companies in the market. Bridging finance can be arranged within a few days or even quicker, in some cases.
- You may be able to borrow up to 75% of the property’s value. You can normally borrow up to 70-75% of the value of the property you’re putting up as security if it’s a ‘first charge’ (i.e. there’s no other mortgage secured on it) and you’re able to make the interest payments, although in some cases this amount may be lower.
- Lenders will look at affordability. Bridging loans companies don’t lend on the basis of income multiples but will look at how much you can afford to repay whether or not you’re paying interest as you go along. If you’re planning to repay the interest then your bank statements etc are likely to be scrutinised more closely.
Bridging loans; pros and cons
The obvious advantage of a bridging loan is that it can buy you breathing space while you sell your property or raise conventional finance, but it’s vital that you have a way of paying off the debt if your plans fall through.
1. Speed. Bridging loans can normally be arranged quickly. In some cases, bridging finance can be arranged within a matter of hours and the speed is a big part of their appeal.
2. Payment levels. If you opt to have the interest retained you don’t have to pay interest until the whole loan is repaid.
3. Flexibility. Loans are flexible and can be paid off as soon as you’re able to.
1. High interest rates. You would typically pay 1-1.5% a month in interest for an open bridge. If you compare that to mortgage rates of 5% APR, you can see how much more expensive it is (it works out at between 12.68 and 19.5% over a year).
2. Fees. Fees for bridging loans can be expensive. You normally have to pay a fee of around 1.5% which will be taken out of the loan. There may be broker fees on top as well as valuation and legal fees.
SAVVY TIP: A good bridging loan company will spend time finding out how you’d repay the loan if your plan ‘A’ fell through. They should look at the worst case scenario such as, if a property won’t sell on the open market, could you put it into auction or rent it out? You must always have an exit strategy with a bridging loan.
Bridging loans and regulation
If a bridging loan is a first charge (i.e. there’s no other mortgage on the property) and it is on the home of the person applying for the bridging loan, or that of her/his family or partner, it is regulated by the Financial Conduct Authority or FCA. That means there are rules about how the mortgage lender operates and you can complain to the Financial Ombudsman Service if there’s a problem. If it is a second charge mortgage (namely there is another mortgage or loan already secured on the property) and it is the applicant’s home or their partner or family’s home, it may have limited FCA regulation.
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