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’s taken out over a short period, which 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 onto 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.
A closed bridging loan has an actual date set in stone for when it needs to be paid off in its entirety. It is 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.
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 during that period. This is often used by people who don’t have a clear strategy of how they will repay the loan, hence it is more flexible and ‘open’ with higher interest rates as well.
Ultimately the right type of loan for you will come down to why you need the loan in the first place.
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 most appropriate. In contrast, 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.
Closed loans tend to be cheaper - as the borrower has a clear exit strategy they are perceived as lower risk to lenders.
How much does a bridging loan cost?
Bridging loans 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.
The simplest option is monthly interest, where you make monthly payments towards the interest charged on your loan. It’s rather like an interest-only mortgage in this respect.
Alternatively, there is deferred interest. As the name suggests, this is where payments are deferred ‒ or put off ‒ until the end of the loan. So you don’t make any payments until the end when you’re ready to pay off the loan, and the interest you’ve accrued on top.
The last option is retained interest, which can be a bit confusing. Here the lender works out what the interest charges are going to 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.
» COMPARE: Bridging loans from UK lenders
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.
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.
Advantages and disadvantages of bridging loans
The big positive to bridging loans is just how quickly you can get the funds. In some cases, bridging loans can go from application to completion within a week, making them a useful option when you’re up against the clock. They can also help you out of a bind and ensure you don’t miss out on a house purchase.
But there’s no escaping the fact that they are an expensive way to borrow, and so should only be taken out if you’re confident of being able to pay them off quickly.
You should also consider what will happen if the property sale falls through but you have already used the bridging loan to purchase a new property. Have a very clear understanding of the impact of this from your lender and where this leaves you.
There are plenty of alternatives you might want to consider, depending on the purpose of the loan. For example, if you’re buying an investment property, it may work out cheaper, albeit slower, to apply for a dedicated buy-to-let mortgage.
» COMPARE: Buy-to-let-mortgages
Is a bridging loan secured?
Yes, the loan is secured against the property you’re buying. As a result, if you cannot make your repayments, the lender could repossess the property to recover the money you owe.
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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