There may be occasions when a property investor needs to cover costs during the period between purchasing a property and completing a sale on another. When that happens, they could need a bridging loan to make up the funds while the property sale financing the new purchase goes through.
But what is a bridging loan, and should you get one for your buy-to-let property? That’s the purpose of this guide, which covers everything you need to know about bridging finance.
What is bridging finance?
Often referred to as a bridge-to-let loan in the buy-to-let market, bridging finance 'bridges the gap' between the purchase of one property and sale of another. Essentially, it’s a short-term option that provides the capital up front to complete a property purchase which will, in theory, be covered by the proceeds of the sale of another asset. This enables the buyer can go through with purchasing their new property without having to wait for the funds from the sale of their other unit.
Bridging finance is common in the business world, where it can allow transactions to progress smoothly while the necessary finance is tied up elsewhere. In that sense, bridging finance works similarly for properties.
In order to obtain bridging finance, the applicant needs to have an exit strategy in place before they can borrow the funds. This would mean selling a property or refinancing it onto another mortgage type.
Bridge-to-let loans, in particular, were created for the buy-to-let market so investors could purchase a property they might otherwise struggle to finance with a conventional mortgage.
How do bridging loans work?
A bridging loan acts as a short-term financing option for anyone without the funds required to complete a property transaction. The lender will release the funds as long as you can show an exit strategy for how you’ll pay the money back. Bridging loans can last for as little as one day but repayments schedules don't normally exceed 18 months.
When it comes to repaying the loan, you will either need to sell a property linked to the loan or raise finance through a traditional mortgage. Any bridging loan you take is also secured against the property (or multiple properties).
How much can you borrow?
With a bridging loan, you can typically borrow between £50,000 and £10m. The amount depends on how much equity you have available and are willing to put into the property. Naturally, most landlords don’t require a loan of £10m to purchase a buy-to-let, but the option is there at the higher end of the market if you can afford the associated costs.
Loans tend to be limited to 75% of the property's value. To illustrate, a property worth £500,000 would require a minimum deposit of £125,000, with the bridging loan amounting to £375,000. The higher your deposit amount the lower the repayments on the bridging loan.
What’s the difference between a closed and open bridging loan?
A closed bridging loan has a set repayment period, which means you will be given a final date for paying off the remaining amount of the loan due. An exit strategy is important here, as it’ll act as the basis of how you make the final payments and will determine whether or not the lender will proceed with your application.
For example, if you’re using the sale of a property to pay off the loan, then you’ll need to have a completion date. Otherwise, you might struggle to borrow with bridging finance if it’s a closed loan.
An open loan is slightly more flexible, though you will still need to have an exit strategy. However, as there is no set repayment period, you have a greater say in deciding how much of the loan you pay off in each repayment and when.
What are first and second charge loans?
First charge loan
If you own the property outright (without a mortgage) and take out a bridging loan, then the lender will have the first charge over the home. That means they will be repaid first as soon as the property is sold.
Second charge loan
With a second charge loan, there may already be existing debt finance on the property. The lender of the initial loan will be the first charge owner, with the second charge being the bridging loan. That means you’ll need permission from the first charge lender before you can access a bridging loan.
What are the pros and cons of bridging finance?
There are several factors to consider when deciding if bridging finance is the right option for you.
A bridging loan offers you fast access to capital, meaning you can keep a property transaction on track should anything go wrong or take longer than anticipated with the sale of another property, or you aren’t able to secure a conventional mortgage right away.
On top of that, you can borrow large sums of money, and the repayment terms tend to be flexible to fit in with your plans once you’ve purchased the property. You can also secure lending on properties where traditional high-street lenders may otherwise turn you down - such as properties that require significant renovation work.
Bridging loans are secured, which means you'll need to put up an asset to get the loan. If you are unable to pay the loan for any reason, that asset then becomes the lender's property.
While bridging loans are fast and flexible, they also have higher interest rates. Expect to pay significantly more when compared to the same level of borrowing with a conventional mortgage. Bridging loans may also come loaded with high fees.
What are the alternatives?
Alternatives include a renovation loan, which allows you to borrow on a property that might need upgrades. Sometimes it's also possible to get a conventional buy-to-let mortgage from a specialist lender, so it's worth exploring your options before committing to a bridging loan. You can also take out a secured personal loan or remortgage the property.
Who offers bridging loans?
Bridging loans aren't as common as they were before the 2008 financial crisis. Lenders impose tighter restrictions, and therefore typical high-street banks don't tend to offer bridging loans as part of their products.
As of right now, Lloyds Bank is one of the few well-known banks to offer bridging loans. However, most lenders are specialists in short-term lending, and you can usually find the best options available with a broker.
Summary: getting a bridging loan
Before taking out a bridging loan, always seek professional advice, as it can be costly. If you don't have a robust plan in place, you may end up owing large sums of money. However, a bridging loan can be a smart move if you need short-term finance, have a clear exit strategy, and can make the repayments.
If you're looking to secure a bridging loan for your property investment, you can use Home Made's free Finance Hub to find the best options tailored to your individual circumstances. Simply fill out a quick questionnaire and our we will find the best, most competitively priced products to help meet your investment goals.
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