What are Bridging Loans and How Do They Work?

You want to buy a new house, but your current property hasn’t sold yet. Or you’ve bought your dream property at auction, but the money just isn’t available in your bank to finish the deal. Or maybe you’re just going through a sticky monetary phase and need short-term funding to pull you through. Bridging loans – or your unknown financial hero.

What is a Bridging Loan?

Let’s get this one out of the way first. A bridging loan is a short-term loan designed to repay a matured debt – usually a property sale – before you can access conventional credit, usually your mortgage, or normal lending options. It’s basically a pause, or a plaster, to help you get by until your long-term funding comes through.

When Do You Use a Bridging Loan?

“Ok,” you think, “I know what it is, but why would I need to use one of these?” There’s a few scenarios in which a bridging loan will be your saviour:

1. When you want to buy a new property without selling the old one

If you’re ready to move into a new house, but your current property hasn’t sold yet, you can take out a bridging loan to use as part of the funds to buy the new property.

2. When you buy property at auction

If you’ve bid on and won a property at auction, you’ll usually have to pay a significant amount of the purchase price as a holding deposit and finish the transaction within just a few days. With a bridging loan, you can do just that.

3. When you’re doing renovations

If you’re going to do some renovations on a property you plan to sell, you can take out a bridging loan to give you the cashflow to get the job started.

How Does a Bridging Loan Work?

Ok ok, let’s get to it. How do the loans actually work?

Bridging Loan Types

There are generally two categories of bridging loans: open and closed.

• Open Bridging Loans: Designed for borrowers who can’t specify a date for loan repayment. You may choose an open bridging loan if you’re awaiting settlement of your existing property, but don’t know exactly when this will occur. You’ll generally be required to repay the loan within 12 months.
• Closed Bridging Loans: Designed for borrowers who can state a date by which the loan must be repaid. If you’ve already exchanged contracts on your existing property but haven’t yet received the funds, you’d use a closed bridging loan to bridge the gap between payments. The term of a closed bridging loan typically ranges from a few weeks to a few months.

How Does the Loan Process Work?

The process of applying for a bridging loan isn’t significantly different from that of a mortgage. It’s just faster and often involves more thorough checks, as the term of the loan is shorter. Here’s how it typically goes:

1. Apply

You’ll complete an application form, providing details about your financials, the property involved (ies), and your intended repayment strategy.

2. Valuation

The lender will likely want to arrange a valuation of the property you’re buying, and possibly the one you’re selling.

3. Approval

If your application gets the green light, you’ll be approved for the loan, usually within a matter of days.

4. Funds Released

The loan amount will be released into your account and you are free to proceed with your purchase or renovation.

5. Repayment

When your property is sold or you obtain permanent financing, you repay the loan in full.

Costs and Interest Rates

We hate this part, the costs. Bridging loans are not cheap. Interest rates are usually higher than that of a conventional mortgage because the loan term is short term and considered high risk. On top of the interest rate, there may also be other costs such as arrangement fees, valuation fees and exit fees.
For example, let’s say you borrowed £200,000. With a standard rate of say 1% per month, you would be paying £2,000 per month in interest alone. If it takes you 6 months to repay the loan, you would have paid £12,000 in interest alone. Ouch! But, as said before, these loans are still worth it in the right scenario.

The Cost of Bridging Loans

We have briefly mentioned interest rates but let’s elaborate a little bit more on the cost of a bridging loan. Other than the monthly interest rate, there are a few other fees you can expect to pay. Arrangement fees can cost as much as 1-2% of the loan amount. Valuation fees vary depending on the property but expect fees in the hundreds of pounds. Lastly, there’s the exit fee which some lenders charge either as a percentage of the loan amount or a flat rate.
Finally, there are the admin fees. Some lenders may charge for paperwork or other administrative purposes. These costs can accumulate but most are usually transparent and known before you proceed.

Pros and Cons of Bridging Loans

Before you dive in head first, you will want to know what potential benefits and drawbacks there may be.

Pros

-Speed: Bridging loans can be arranged quicker than conventional mortgages.
-Flexibility: They are not restricted to property purposes only.
-No Monthly Repayments: The interest is usually rolled up and added to the capital, allowing for the whole loan to be repaid at the end of the term. This eases any cash flow concerns.

Cons

-Cost: As mentioned, these loans are not cheap.
-Risk: If your property does not sell or your finance is not secured, you may find yourself in a difficult position.
-Short Term: These loans are meant for short term purposes only so if you require long term finance, this is not for you.

Tips for Using Bridging Loans

Ok, ok. You’re still reading. I like you. Very much. So here are a few tips on how you can make best use of a bridging loan:

1. Have an Exit Strategy: You must know how you are going to repay the loan and when. The sale of a property, remortgaging or some other method. Plan it down to the last detail.
2. Compare Lenders: Don’t just opt for the first lender that appears on top of search results. Shop around and compare rates, fees and terms before committing to one.
3. Know What You’re Getting Into: As with any financial product, read the small print and understand what you are agreeing to. If you don’t understand, ask questions.
4. Minimise Costs: Only borrow what you need to and what you can afford to repay. You are not cheap and we know you are paying for this privilege.

Popular Myths

So here are a couple of examples of things that I regularly get told about bridging loans that are simply not the case:

• Just for Property Developers: No! They are popular for developers but can be used by anyone who needs short term finance.
• Too Costly to consider: They are more expensive than traditional financing, but if utilised properly the rewards can far outweigh the cost.
• Difficult to obtain: They do require good credit history and a viable proposal but are by no means impossible to obtain. 

Wrapping Up

So there you have it, bridging loans 101. They are not for the faint hearted but when used in the right circumstances these loans are an absolute force to be reckoned with. Whether you are chain free and need to buy before you sell, or you want to buy a property at auction or even renovate a property bridging loans will certainly get you from A to B with very little hassle in between.