How A Bridging Loan Can Finance Property Purchases
A bridging loan acts as a bridge between the sale of one property and the purchasing of another. It is a short-term option that helps bridge a gap, making it possible to buy a new house before selling your old one.
A bridging loan is a type of property loan that is taken out over a short period. It can range from just a couple of months to a year. This type of flexible financing is popular with landlords, property developers and sometimes individuals who are moving house.
As the name suggests, the loan is there to act as a bridge before you move on to a more long-term solution. It might be that you want to buy an investment property at an auction, do it up, and then sell it on at a profit, for example.
Or it might be that you have found your dream home and agreed on a completion date, but you are yet to complete the sale of your existing property. A bridging loan can help you bridge that gap.
You can get a bridging loan for a wide range of values too, from tens of thousands of pounds to millions in some cases.
How does a bridging loan work?
Bridging loans work differently depending on which type you choose: open or closed.
Closed bridging loan
A closed bridging loan has an actual date set in stone for when it needs to be paid off, although it’s also possible to pay off this type of bridging loan early.
Closed bridging loans are often used by those who have a clear plan of how and when they will be able to repay the loan as they have more certainty over when funds will become available. For this reason, interest rates are often lower.
So, if you are just looking to bridge between buying a new property and the sale of your existing home, and have completion dates already set for both, then a closed bridging loan may be worth considering.
Open bridging loan
An open bridging loan will still have a maximum term, of, say, six to 12 months, but you can pay the loan back at any point, or even piecemeal, during that period. This is often used by people who don’t have a clear strategy with a concrete timeline of how they will repay the loan, hence it is more flexible and ‘open’ with higher interest rates as well.
If you’re buying an investment property and plan to remortgage after carrying out some refurbishments, then you might prefer the flexibility that comes with an open bridging loan since you don’t know exactly when that work will be finished.
How much does a bridging loan cost?
Bridging loans are a type of interest-only loan. This means that you only repay the interest on the loan each month. And you don’t have to pay the amount you borrowed until the end of the loan term.
They often come with relatively low interest rates. But that doesn’t mean they are a cheap way to borrow, since loans are usually priced on a monthly basis rather than the annual basis you see with mortgages and other forms of credit.
As a result, if you take a while to pay it off, it could become more expensive.
It’s also important to note there are three different ways you can be charged interest on your bridging loan, which will impact how much it costs overall. These include:
- Monthly interest: Where you make monthly payments towards the interest charged on your loan. It’s quite similar to an interest only mortgage.
- Deferred or ‘rolled up’ interest: This is where payments are deferred ‒ or put off ‒ until the end of the loan. This means that you won’t have to pay monthly interest payments. Instead, the interest is ‘rolled up’ or compounded and paid as a lump sum at the end of the loan term.
- Retained interest: Here, the lender works out what the interest charges will be for the whole life of the loan from the very beginning, and then adds that to what you actually need to borrow. For example, you might need £100,000 and the lender calculates that over a six-month term you’ll build up interest charges of £10,000 so you’ll have to borrow £110,000 in order to get the £100,000 you need, and pay the lot off in full at the end of the loan.
On top of interest, lenders also charge a range of fees, such as arrangement fees, valuation fees and even exit fees if you pay the loan off early.
How to get a bridging loan
There are dozens of different lenders active in the UK who offer bridging loans, whether you’re looking to use one for your home or for an investment property.
Importantly some of these lenders ‒ particularly those who focus most of their efforts on short-term property loans like bridging loans ‒ only offer their products through independent mortgage advisers.
Mortgage advisers can help you work out the product best suited to your needs and which lender is most likely to approve your application, though you will likely have to pay for that advice.
» COMPARE: Bridging loans from UK lenders
Is a bridging loan secured?
Yes, a bridging loan is a type of secured loan. That means that you’ll need to use a physical asset, such as a house, as collateral to borrow money in case you can’t repay your loan.
If you aren’t able to pay off your bridging loan the lender keeps the asset to recover any money you owe.
Pros and cons of bridging loans
There are several advantages to using a bridging loan including:
- Flexibility: Typically lenders have more flexible lending criteria for bridging loans compared to traditional loans, which could improve your chances of being accepted for one.
- Quick to arrange: Bridging loans tend to be arranged more quickly than other forms of borrowing, and some lenders pay out within 48 hours of approving your application.
- Borrow large sums: You can often borrow a large amount of money using a bridging loan.
- Non-standard properties: Some lenders offer bridging loans for non-standard properties, such as thatched properties or homes with flat roofs, which aren’t always accepted by high street providers.
Some of the disadvantages of using bridging loans to look out for include:
- High interest: Bridging loans are designed for short-term borrowing, which means that the interest rates tend to be more expensive.
- Fees: Lenders often charge a range of administrative fees which can make borrowing money through a bridging loan more expensive.
- Secured loan: You may lose an asset if you’re not able to repay your bridging loan.
Image source: Getty Images
John Fitzsimons has been writing about finance since 2007. He is the former editor of Mortgage Solutions and loveMONEY and his work has appeared in The Sunday Times, The Mirror, The Sun and Forbes. Read more
Brean is a personal finance writer at NerdWallet. She covers a range of financial topics and has written for consumer titles including Which?, Moneywise and The Motley Fool. Read more