In some situations, bridging loans can mean the difference between losing a property you have made an offer on and successful completion. A short-term loan designed specifically for the housing market, this kind of credit comes with risks as well as benefits.
In this guide, we talk you through what a bridging loan is and how they work plus take a look at some of the pros and cons you will need to consider before deciding if this option of alternative financing is for you.
What is a Bridging Loan?
A bridging loan is a short-term line of credit offered by money lenders specifically for people to complete a property purchase.
As the name would suggest, they are a way to overcome a gap between when you purchase a home and when the sale of your own property goes through. For instance, in the event that you are in a chain and the completion date of your purchase need to happen before the sale of your own home goes through then a bridging loan could be an option to ‘bridge’ that gap.
Another common circumstance in which these kinds of short-term loans are ideal is for when people purchase a property at auction.
In short, bridging finance is offered as a solution to a temporary cashflow problem. They are available for any kind of buyer but have become popular with amateur property developers, landlords and wealthy (or, asset-rich) homeowners who have sizeable equity in their homes.
How Do Bridging Loans Work?
Bridging loans are offered by a variety of lenders including traditional mortgage companies, banks, building societies and finance agencies.
There are two types of bridging loan offered by the market, both of which are secured types of loans meaning that you must have assets tied to the contract. In this way, your home (or other asset) is at risk if you cannot meet the monthly repayment schedule.
The first type of bridging loan is the most commonly used variety when purchasing a property and is known as a ‘Closed Bridging Loan’. This kind of finance is exclusively available to those parties who have already exchanged on a property but need a short-term loan to help them secure the home between completion of their own home and that of the purchase property.
A Closed Bridging Loan is easier to arrange than the alternative option (see below) as lenders consider there to be less risk as the sale (and eventual completion of the chain) is unlikely to fall through following exchange.
The second type of bridging finance available is known as an ‘Open Bridging Loan’ and is popular with those people who have found a property they wish to purchase but have not sold their own home yet in order to finance it.
An Open Bridging Loan is riskier for lenders and can often attract much higher rates of interest as a result. Given the fact that there are no guarantees of a sale of your own home, lenders usually only accept people who have plenty of equity in their property for this kind of finance.
Pros and Cons of a Bridging Loan
The main benefit of a bridging loan is accessing funds before the sale of your own assets have been realised. With an Open Bridging Loan, this can mean that a buyer is able to act swiftly in the purchase of a property putting them in a much more favourable position that competing buyers. It also means that they can access properties being sold at auction as they will be able to complete within the short timescales set by the auctioneer. In this way, bridging loans are ideal for Buy-To-Let landlords and small-scale property developers.
Put simply, bridging finance is an invaluable method of being able to purchase a property that otherwise would not be possible.
The downside of a bridging loan is the expense.
With significantly higher rates of interest, a stop-gap loan of this type comes with a sizeable price tag and are much more expensive that ‘normal’ loans. This kind of product is designed for short periods with most lenders offering finance for anything from one month to twelve months maximum although some companies will consider longer periods.
In a way, you could consider a bridging loan as being similar to a Payday Loan; they are more of an emergency line of credit rather than a sustainable way to manage your finances.
Lastly, a bridging loan could affect your credit score so make sure you consider the implications with your financial adviser before taking one out.
How Much Does a Bridging Loan Costs?
Rates of interest for a bridging loan vary by lender and can range from as little as 0.3% per month to 5%+ per month; typically, you would be looking at a rate of between 1% to 3%. Though these figures look similar to a mortgage, you need to remember that these are presented as monthly interest rates. Compare these figures to an annual interest rate and you can quickly see how 0.3% per month adds up to 3.6% and much higher. If the average interest rate is 1.5% then this would equate to a loan being subject to an APR of 18%!
In addition to the higher rates of interest, most bridging loans also come with some pretty hefty arrangement fees. Again, these vary by lender and can either be fixed or a percentage of the loan you are organising. Some lenders charge bookended fees so you must pay to ‘exit’ the loan as well as to arrange it.
As with any kind of financing you are considering, it is extremely important that you fully understand the commitment you are making before signing up. This includes looking carefully at the interest rates and being clear on whether these are fixed or variable plus making sure you understand any other fees that could be incurred such as arrangement fees and exit (or settlement) charges.
Alternatives to a Bridging Loan
Whilst the idea of a bridging loan may be tempting in order to secure the purchase of a property you have invested time, effort and (possibly) money in, it is not the only solution available.
It is generally considered that (as with a payday load), bridging finance should be a last resort and not a first port of call.
If you are considering this kind of finance due to a cashflow deficit resulting from gaps in the dates between exchange and completion then it is worth, first, speaking directly with the parties involved in your chain. Nobody wants the chain to break down and you may find that there is more flexibility with dates if you make it clear to your solicitors and the seller.
If there is no ‘wiggle room’ with the timings of your purchase then, depending on the figure you need, you could also consider a personal loan or a second mortgage. Both of these types of borrowing may have implications on any first mortgage you are arranging to secure a property you are buying so always speak to your mortgage adviser or an IFA first.
Lastly, some families are in a position to be able to help in these circumstances and there is a big difference between borrowing a sum of money indefinitely and asking for help to ‘bridge’ a cashflow problem of this type. Certainly, if you are in a position where you have exchanged then the risk is minimised. Parents may be able to help in these circumstances but always make sure that you consider the impact that borrowing from relatives can have on relationships. It is not an ideal solution and, for many, may be an unpalatable option but may end up being significantly less expensive than a bridging loan.
Arranging a Bridging Loan
As we mentioned above, there are a huge variety of lenders who offer bridging loans from high street banks and building societies to specialist finance companies.
Depending on whether your lender is offering a first or second charge on the property against which the bridging loan is secured will determine how they are regulated but it is always recommended that you use a company that is governed by the Financial Conduct Authority (FCA).
Lastly, always seek the advice of a financial adviser before committing to borrowing of this nature to ensure that you opt for a suitable product that is affordable and will not leave you at risk when it comes to any future borrowing requirements.
Property Assistant does not provide financial advice but we do aim to take the hassle out of the buying process. We know just how stressful managing a chain can be and how organising finances can be an additional, and huge, burden on your time. That’s why we not only work hard to help buyers find their dream homes and sellers to secure the best asking prices, we also dedicate our resources to providing a first-class aftersales support service.
To find out more about why our customers recommend us, contact us today on 0118 912 2370.