What is a Bridging Loan?
A bridging loan, also known as gap finance, is the financial term commonly used to describe a method of short term secured finance that funds a property purchase whilst the sale of other assets is still in progress.
A bridging loan enables the property transaction to take place, without delay by applying the equity owned within a current property as a deposit towards another property. The result is that the client owns multiple properties while further transactions are proceeding.
What are the Differences Between a Bridging Loan and Standard Mortgage?
The short-term nature of a bridging loan, that provides the flexibility required in certain circumstances is the major difference between a standard mortgage. Most standard mortgages have a repayment duration of up to 35 years, whereas a bridging loan usually will typically have repayment terms of between 12 and 24 months.
Often a lender’s decision on a bridging loan application will be received within a few days, which is substantially quicker than the response from a standard mortgage application.
This speed in the approval process can provide flexibility and aid decision making for purchasers. One example of where the speed of approval can be crucial is when a property chain breaks down by a buyer pulling out. In this scenario, the ‘upward chain’ of the purchase could be salvaged by the use of a bridging loan.
The repayment of interest can be delayed on bridging loans until the end of the loan period. If this option is selected, the interest would be payable at the end of the bridging loan term, along with the principal amount.
This option can provide significant cost savings during the term of the loan compared to a standard mortgage, where this option is not usually available. However, a consideration is that if the interest repayment is postponed, the total amount borrowed must include the interest total due.
Loan to value rates
There is often higher loan to value lending available via a bridging loan compared with a standard mortgage. Typically, a bridging loan’s terms could offer a loan to value rate of up to 80%, offering increased flexibility with financing.
With a standard mortgage, the principal value is paid off throughout the duration of the loan, however with a bridging loan an exit strategy is required to map out a plan to pay off the loan. Due to the short-term nature of a bridging loan, an exit strategy will need to be proposed during the application process, detailing a plan of how the loan will be repaid at the end of the loan.
High street lenders will not offer finance against properties with certain characteristics such as; properties without functional kitchens and bathrooms or properties with structural concerns, however, the criteria for bridging loans are often more flexible and therefore may be an option should the property type be an issue upon a standard mortgage application.
Read our related quick help guides:
- Bridging loans for property development.
- A guide to bridging loans brokers.
- Bridging loan examples.
- Alternatives to bridging loans.
- Development finance.
- Construction loans.
Bridging Loan Examples:
Example 1 – Buying a House with a Bridging Loan
It has become more commonplace within recent years for bridging loans to be used to fund the purchase of a house, due to the benefits of this type of finance, such as:
- Speed – A bridging loan can usually be arranged promptly and therefore the property purchase can often complete quickly. The property chain can often treat purchasers using bridging loans as cash buyers and therefore can be favoured above other contenders that need to sell the property first, before proceeding.
An example of where the speed of a transaction is crucial is at a property auction when an investor would require access to funds quickly to fund deposits so they do not miss out on the property lot. Other scenarios when the speed of a property transaction may be beneficial include; investment purchases or the funding of business ventures, tax bills or divorce settlements.
- Flexibility – Bridging loans lenders are specialised and therefore often have different borrowing criteria to high street lenders. As such, potential borrowers with a less than perfect credit score, or those fluctuating incomes could be granted access to this type of loans, secured against the property value.
Bridging loans can also be used to break a mortgage chain providing increased flexibility of the timing of further property purchases.
- Variety -Bridging loans can be applied against both residential and commercial property types, including building plots without planning permission, therefore providing quick access to funding for a variety of investment opportunities.
Example 2 – Downsizing with the use of a Bridging Loan
Within a downsizing scenario, the property owners may require a slower-paced property hunt, either to undertake renovations on the property that will be sold or to provide extra time to search for the perfect smaller property. Therefore, a bridging loan could finance the gap between the sale of the larger property, to fund the downsized purchase.
With a longer timeframe available, the market can be scoured for the best lending rates available.
Example 3 – Relocation
A property relocation may sometimes be needed for a variety of reasons such as a work opportunity or family commitments, however often timings can be challenging. In these circumstances, sometimes a new property is required to be purchased for the relocation purpose before currently owned property is sold. A bridging loan can be an ideal solution to finance the move whilst the original property is put on the market.
How much does a Bridging loan Cost?
The interest costs on bridging loans can seem fairly high, typically around 0.4% – 1.5% a month, however the duration of the loan must be considered to calculate the overall costs.
There are also additional charges to be taken into consideration such as arrangement fees, and sometimes exit fees applied by the lender. As with a standard mortgage, legal fees, valuation costs and bank transfer fees will also be payable.
Bridging Loan Examples Summary
As with any financial transaction, there will be pros and cons of the options available, and therefore it is recommended that advice is sought from an independent mortgage advisor to review the entire situation as well as the applicants’ personal circumstances.
Specialist brokers often have access to the entire financial market and can therefore provide a wide range of quotes from a wide variety of bridging lenders.
Give us a call on 01925 906 210 or get in touch for advice that is personal to you and takes your credit history into account. That way you will know where you stand in the development finance market and we can guide you on your route to securing a suitable loan.