The Benefits and Risks of Bridging Loans
A bridging loan is a great solution for property developers and investors that need fast funding for their property venture.
They offer increased flexibility and lending criteria making them a great option for borrowers, especially in uncertain economic times such as Brexit.
Like all finance solutions, there are benefits and risks to be aware of. So, if you’re thinking of taking out a bridging loan, here are some factors for you to consider…
Benefits of a Bridging Loan
Fast to arrange
One of the biggest benefits of bridging loans is that they can be completed fast with the finance available to use within a matter of weeks, and in some cases even a matter of days.
The commercial bridging market is currently un-regulated, which means approvals can happen a lot quicker than traditional finance such as mortgages.
The ability to obtain funds quick is essential for developers and investors that are met with opportunities to act on or issues to deal with. Securing a bridging loan quickly can make all the difference to the success or failure of a project.
Unlike traditional mortgages that are typically only applicable for habitable properties, bridging loans are available for a variety of purposes; such as purchasing inhabitable property, auction purchases, breaking the property chain, and paying for renovations and construction work.
Additionally, with a traditional mortgage, the lender has the first call on any funds that come from the property sale, also known as a ‘first charge’. However, a bridging loan can be approved as a second or even third charge, which means lenders will still issue bridging loans on properties that already have finance in place.
Bridging loan terms will vary from lender to lender; however, the average lender will agree to a bridging loan of up to 75% of the purchase price with some lenders even agreeing to 100% bridging loans – providing sufficient security is in place.
In general, most lenders offer bridging loan terms from 1 month up to 1 year.
Many mortgage providers will only lend against property that is habitable or classed as standard construction. Bridging loans can be secured against property that is non-standard or unusual construction.
This means a lender will secure against any type of property, even if it is in poor condition, derelict or in need of major refurbishment.
Additionally, some bridging providers also lend against more than one property on a first or second charge basis.
Wider lending criteria
While a standard mortgage requires excellent credit and a habitable property as security, bridging loans are often considered on the projects’ profitability, exit strategy and the borrowers’ overall experience in the industry.
Every lenders’ criteria will vary, but in general, bridging lenders are not overly concerned with income, affordability and credit history and are more concerned by individual success of the project.
Some bridging loans are structured so that the borrower pays interest each month, however most are typically required to be paid back at the end of the loan term, usually by selling a property or refinancing it.
Unlike standard mortgages, borrowers can add their monthly interest payments to the final payment, so they do not have to make repayments during the term of the loan.
This is beneficial for developers or investors that need the loan to purchase or renovate property but do not yet have an income to cover the monthly payments.
No early exit fees
Most bridging loans are re-payable after the first month, usually without any exit fees. This is because most lenders make their profit from the arrangement fee or interest fees on the loan. This means borrowers do not have to worry about paying an exit fee if the loan is repaid early.
Risks of a Bridging Loan
High interest rates
As bridging loans are designed as a short-term finance solution, the interest is charged at a monthly rate instead of an annual rate.
The interest rates of a bridging loan are higher than a standard mortgage and will require a well-planned exit strategy to repay the loan. This is due to the flexibility and wide lending criteria of a bridging loan that a standard mortgage would not usually consider.
As well as paying back the loan with high interest rates, borrowers should also expect to pay arrangement and broker fees (often around 1.5%), valuation fees and any legal fees required. These will vary from each individual lender and broker.
Currently unregulated for investment purchases
Bridging loans for commercial property are currently non-regulated. Although this makes it possible for lenders to be flexible and provides funds quicker than a standard mortgage, it also means borrowers do not have the protection of the Financial Conduct Authority (FCA).
Risk of repossession
Like most finance options, if the loan amount is not repaid within the terms of the agreement, the borrower could face significant costs and even repossession of the property.
Before taking out a bridging loan, it’s recommended to speak to an expert. An experienced broker will be able to guide you in the right direction and find the best finance solution for your project.