Bridging loans are a short-term loan solution that is useful for bridging personal financial gaps and can also be helpful for some businesses.
If you're looking to purchase a new house but are also in the process of selling your old one, a bridging loan can help you.
Bridging the gap in personal finances is one of the benefits bridging loans offer. In this article, you'll learn all about bridging loans, what they are, and more.
What Is a Bridging Loan?
A bridging loan, sometimes known as a bridge loan, is a short-term secured loan.
Like other secured loans, Bridging loans require some form of collateral to take out the loan. As bridging loans are predominantly used to help finance an additional property purchase, the property itself or an already-owned property is used as collateral. Bridging loans typically have higher rates than other secured loans and have much shorter terms, usually up to one year.
There are four types of bridging loans you can apply for:
- Open bridging loan: When you apply for an open bridging loan, the repayment method isn't determined, and there is no fixed payoff date. If you know you're due to gain more finances in the future but don't know when an open bridge loan may be ideal. Due to the uncertainty of when you plan to pay the lender back, lenders charge higher interest rates for this bridging loan. Most bridging lenders will deduct the loan interest from the loan advance.
- Closed bridging loan: The time frame of closed bridging loans is agreed upon by both parties. Having a fixed date makes lenders more likely to give candidates a loan and typically offer lower interest rates than an open bridging loan.
- First charge bridging loan: If you don't have any other secured loans out on the property, for example, you already own it, it will be a first charge bridging loan. So, if you failed to repay the loan and the property was sold to pay off debt, the bridging loan lender will receive repayment first. This loan is less risky for lenders, so typically, they offer the lowest bridging loan rates.
- Second charge bridging loan: A second charge bridging loan is similar to the first charge. However, the bridging loan lender will receive the repayment second if both parties are already involved. Second-charge loans have higher interest rates than the first charge.
The idea is to repay the loan when the sale of an existing property goes through, as the loan is to help bridge a financial gap. Typically, you'll repay the loan at the end of the term, but you may have to make monthly interest payments and cover the cost of some upfront fees.
Also Read: Best Secured Loans UK in 2024
How Are Bridging Loans Different to Mortgages?
Although bridging loans can help finance a new property, they differ from mortgages.
Both mortgages and a bridge loan are secured loans that require an asset as security. However, Mortgages are long-term commitments, usually around 25 years, whereas bridging loans are short-term secured loans that typically last up to 12 months.
The overall process for getting a loan is much longer than the one for a bridging loan; with a bridging loan, you can get funds within a few weeks, whereas a mortgage may take up to six weeks or more. Interest rates also differ between the two loans. For example, interest rates are higher for bridging loans because they're riskier.
Repayment options are more flexible with bridging loans, as you can choose an open or closed loan and decide when you repay the loan. There are options for interest-only payment plans to deferred payments, too.
A mortgage is a closed loan with strict penalties for payment failures. It usually has a charge for early repayment, sometimes making it more expensive to make an early repayment than it would to continue the loan.
Pros and Cons of Bridging Finance
Bridging finance is a short-term solution for bridging the financial gap; although helpful, there are pros and cons to taking out a bridging loan.
Below, we explore them all to help you decide if it's the right option.
| Pros | Cons |
|---|---|
| ✔️ Speedy funding: To get a bridging loan is a relatively quick process. Bridging loans is an efficient method of securing funds for buying a mortgage when mortgages or personal loans are viable. Once you've applied for the loan, you may receive the funds within two weeks, sometimes even days. | ❌️ High-interest rates: With a bridging loan, interest rates are usually higher than if you were trying to secure a mortgage, making it a more expensive finance option. Depending on the bridging loan you take out will determine if the interest rate you pay is high or low. Typically, you can expect to pay 0.5-2% interest per month. |
| ✔️ Flexible loan options: You can choose an open or closed loan and decide when you repay the loan. There are options for interest-only payment plans to deferred payments, too. | ❌️ Fees: There are many fees involved in bridging loans, such as legal fees, broker fees, exit fees, a facility fee and more. However, you can choose when to pay most of the fees. You have to pay upfront for some, but you can pay fees monthly or at the end of the agreed term. |
| ✔️ Unmortgageable property: Banks and other financial institutions are limited on the types of properties and conditions they can lend against. However, bridging finance companies have fewer limitations. If you're looking for a fixer-upper or something you can work on in the future, you may be more inclined to lend for those properties using a bridging loan. | ❌️ Short-term option: Bridging loan duration is typically up to a year, so you will only have a short time to repay it. Equally, bridging loans are generally short-term debt you pay off when your term ends or a property sells. |
| ✔️ Loan size: With mortgages, the loan amount is determined by the borrower's income and expense, whereas bridging loans are determined by asset value. You could receive a high loan amount if you've properties with a high value. | ❌️ Risk of losing collateral: If you struggle to repay the bridging loan, you could lose the security you put up as collateral. For example, if the sale falls through on your selling property due to dips in the market property, you could have issues with the loan. |
Also Read: Best Bridging Loan Companies UK
How Much Does a Bridging Loan Cost?
The bridging loan cost will vary between lenders, brokers, and the property on which you're taking out the loan.
Costs and fees will vary between loans, but we've compiled a list of all the potential bridging loan costs you may come across, with a general idea of how much each fee is valued.
The bridging loan cost includes:
- Deposit: When buying a property or taking out a loan for a property, the bridging loan broker requires you to make a downpayment beforehand. Typically, deposits are around 25% of the property amount. The higher your deposit, the less money you'll have to borrow.
- Facility fee: The lender will charge a one-time arrangement fee, usually 1-3% of the loan amount. Sometimes, arrangement fees are waived for larger bridging loans.
- Monthly interest payments: There are monthly interest charges when you take out a bridging loan. Interest payments are usually 0.5-2% of the monthly loan amount.
- Exit fees: Some lenders usually charge an exit fee of around 1-2% of the loan amount when the bridging loan is paid.
- Valuation fees: When the property is being evaluated, there will be valuation fees to cover the cost of the property valuation report.
- Broker fees: Although brokers are optional, if you choose to use one, broker fees typically range from 0.5%-2% of the loan amount.
- Legal fees: Any legal work needed for the loan will cost a legal fee that ranges from £500 to £2,000.
- Administration fees: Bridging loan lenders will charge a one-time admin fee for setting up the loan. Admin fees start from £500.
- Early repayment charge: If you repay the loan before the loan term ends, there is usually an early repayment fee that's 1-5% of the outstanding balance.
- Rolling up interest: Some bridging loan lenders have added interest to each month's loan balance. Depending on your credit history and the provider's bridging loan rates, you'll need to consider the bridging loan interest rate as part of the costs. You may pay a monthly interest rate depending on your chosen payment option.
How to Reduce the Cost of a Bridging Loan
The best way to reduce the cost of a bridging loan is to pay a higher deposit, which will lower the net loan and loan-to-value ratio (LTV), which may also reduce your monthly interest payments.
However, putting down a larger deposit will further strain your financial situation; you may want to consider a lower deposit. If you've put down one property as collateral for the loan, if you own multiple, you could reduce your LTV by offering another property on top of the original one.
When Do You Pay Bridging Loan Fees?
Most bridging loan fees are included in the loan itself, and you choose to pay them at the end of your agreed term.
Usually, the most convenient method for you is how payment of fees goes. However, if you pay the fees at the end of the agreed term, you will pay interest. Some of the fees you have to pay upfront, such as legal fees, valuation fees, and broker's fees.
What Interest Rates Can You Expect for a Bridging Loan?
Bridging loan interest ranges from 0.43% up to 1.25% per month.
However, the more risk the lender is exposed to, the higher the interest rate. The higher the LTV, the higher the interest rate. With bridging loans, you can expect the maximum LTV to be up to 85%.
Interest rates will differ between fees, too. Still, if you use the lender's loan calculator before filling out your application, you may better know how much interest you'll pay each month or at the end of the term, depending on when you agree.
Other factors that affect bridging loan interest rates include:
- Property value: If lenders don't think a property will sell or face difficulty selling, interest rates may be higher.
- Credit history: If you have a good or excellent credit score, you're more likely to be seen as a lower risk than someone with a bad credit score. You may benefit from lower interest rates.
- Loan to value ratio: The higher the LTV, the higher the interest rate is likely to be, so if you can put down a bigger deposit and lower your LTV, you may reduce interest rates.
- Term length: Shorter loan terms typically have lower interest rates than longer terms, so if you can get a loan that's as short as possible (as well as manageable) to less interest, you'll pay back.
- Security on the loan: Loans secured on property often have lower interest rates than unsecured loans. If you can't repay the loan, the provider keeps the security so they're not out of pocket from the lending and typically offer lower interest rates.
- Loan amount: For higher loan amounts, for example, above £500,000, some lenders may have higher interest rates than bridging loans below £500,000.
- Additional fees: Arrangement fees and early repayment charges can increase costs; these fees will vary between lenders.
What Is a Bridging Loan Calculator?
A bridging loan calculator can help you determine the LTV ratio and estimate the bridging loan cost before applying.
You can work out monthly payments, monthly interest and how much the overall loan will cost you in the long run.
Most lenders will have a bridging loan calculator on their website, but if not, many online are free to use. All you'll need information you'll need is:
- Loan amount required: You must know the total net loan you wish to borrow. You should know this from the property value you want to buy minus your deposit amount. The amount you enter should be before interest is added.
- Term required: You must add the maximum number of months you plan to take out the loan. Most lenders offer a bridging loan for 12 months, but some may offer longer, so check out to ensure you know the terms they provide for an accurate estimation.
- Value of the property: You must include the estimated market value of the property used as security. If you're offering up multiple properties for securities, you will also need their market value.
- Mortgage balance: If any unclear mortgages are secured on the property, you must include the outstanding balance.
- Interest payment method: You decide with your lender if the interest is rolled up so it’s charged at the end of each month and then added to the balance so it will be paid when the loan is redeemed, or you can pick monthly interest payments which mean interest is charged and paid at the end of each month.
If you're using a lender's calculator, it will tell you the gross loan amount and all of the fees included. Calculations help you determine the affordability of the bridging loan before you fill out an application.
Final Thoughts
A bridging loan is an ideal alternative to a mortgage or other finance options like unsecured loans. You have more flexible payment options, you can buy a broader range of properties, and your income doesn't determine the loan amount. However, risks are involved, like potentially losing your security assets, which is something to be mindful of.
If you're unsure if a bridging loan is right, please speak with a professional financial advisor before taking out a loan.
