What Are Bridging Loans and How Do They Work?

Bridging loans are short-term loans that  are secured against property. They are not mortgages although work in a similar way albeit for a much shorter period.

Banks and building societies began to offer bridging loans in the 1960s to residential homebuyers. The loans were a niche product to ‘bridge’ the gap between selling one property and buying another. 

More recently, this type of loan has grown in popularity and is primarily used by commercial  property investors and developers. A change in attitudes towards bridging loans has largely been driven by a reduction in  bridging finance costs and rising standards in the industry. 

Who are bridging loans for?

Bridging loans suit a number of purposes and are used by many people. The reasons for taking a loan include: completing a property purchase quickly, financing property refurbishments, paying off outstanding arrears whilst arranging a new deal, and buying a property before selling your existing one.

They are used by both property investors and homeowners to fund urgent, unusual or profitable financial transactions. Bridging loans for property developers can generate significant profits by allowing the developer to take on larger projects. 

Bridging loans are regularly mentioned in the TV series ‘Grand Designs’ that follows house building projects when work comes to a stop and money runs out. A loan is quickly arranged to complete the project.

As bridging loans are a relatively bespoke product and designed to be flexible, the reality is that there is no ‘one size fits all’ reason for taking out a bridging loan.

What can I use a bridging loan for?

Bridging loans are flexible and can be used in a range of circumstances, here are some of the common reasons people decide to choose this type of loan:

Buying a property before your current home has been sold

This is a very common reason for a residential bridging loan and allows homebuyers to proceed with a purchase whilst they are waiting to sell their home. 

Fixing a broken property chain after a sale falls through

If your house purchase is part of a chain and a sale falls through, a speedy bridging loan can ensure that you have the funds to buy your new property. This option allows you time to put your home back on the market without breaking the property chain and losing out on the home you want to buy.

Buying a property at auction 

In most cases you will have 28 days to pay for a property bought at auction. You will pay 10% of the value upfront and then pay the remaining 90% within a month, if you cannot pay the outstanding amount you will forfeit the deposit. 

It is unlikely that a mortgage can be arranged in 28 days and many auction properties are in a state of disrepair meaning that traditional lenders would not provide a loan. By using a bridging loan a property can be improved to the point where a ‘normal’ mortgage with lower interest rates can be sought. 

Investing in a buy-to-let property 

Similar to renovation projects, a buy-to-let property may need work before it can be rented to tenants to generate income. A mortgage lender will not provide a buy-to-let mortgage until the property is in a suitable condition and this can include ensuring safety features, such as fire doors, are in place.

Taking a short term bridging loan to bring a property up to the required standard to achieve a buy-to-let loan is a common practice. A bridging lender would expect to see an exit plan that involved getting a long term mortgage to pay the bridging funds.

Land purchase

Much is said about bridging loans and property, however, they can also be used to purchase land with the intention of applying for planning permission. Once planning permission is granted you could refinance with development finance to provide funds for a build.

What are the types of bridging loans?

There are two main types of bridging loans, these are open and closed bridge loans:

Open bridge loans do not have a specific repayment date; they are, however, still regarded as short to medium term loans by lenders and so will need to be paid back within a year to two years. These loans are flexible and, as a result, come with higher costs.

Closed bridge loans have a fixed repayment date and are ordinarily used whilst house buyers are waiting for completion on a sale. These loans are less costly than open bridge loans.

A first charge loan is when there is only one loan secured against a property provided by a single lender, this could be a mortgage. In this situation the lender has the first claim on the property in the event of a default. 

A second charge bridging loan is where there is already a loan secured against a property. In a default situation a property would be sold and the first charge loan would be paid before the second charge loan.

The difference between these two loans is that a first charge loan is usually for a higher amount than a second charge loan and is often used to purchase a property or undertake substantial work.

A second charge loan typically provides funds for renovations or to access cash flow during a property sale.

How do bridging loans work and how much do they cost?

Bridging loans work by providing short term funding secured on property where traditional loans are not applicable. Reasons you may take a bridging loan are that your house hasn’t sold and you are buying another house, or you want to develop a property and sell it.

The amount you can borrow with a bridging loan varies and is dependent on the equity available, which is what a property is worth (or will be worth when it has been renovated) minus any outstanding liabilities or loans. An average range for bridging loan boring is between £50,000 and £10 million. 

The maximum loan amount is normally up to 75% loan-to-value, so 75% of what the property is worth. This is a figure set by the Financial Conduct Authority. Not all loans are regulated and whilst some lenders will provide a higher loan-to-value these are unregulated loans that do not offer the oversight and protection that the FCA provides.

An example of how a bridging loan would work:

1. You want to buy a house for £600,000 and you need to put down a £200,000 deposit and borrow the rest on a mortgage.
2. Your house hasn’t sold yet and you only have £50,000 in savings.
3. You ‘bridge’ the gap and get a bridging loan for £150,000 to cover the deposit until you sell your house.
4. When your house sells you pay off the bridging loan with interest (accrued on a monthly basis and payable at the point of loan exit.) 

How much does a bridging loan cost?

Bridging loan costs vary depending on your circumstances and choice of lender, although interest rates can be as low as 0.5%. It’s worth noting that there are a number of fees that are added to a bridging loan and these should be included in your estimate when you are comparing products.

Use our free bridging loan calculator to get an estimate of what your costs would be.

Bridging loan fees

A bridging loan is a legal arrangement where a ‘charge’ is placed on a property giving a lender an interest in the property. This means that if you default on payments a lender will be able to sell the property to recoup their money.

In addition to interest payments for the loan, you can expect to pay arrangement, exit, administration, valuation and legal fees.

Many lenders will expect you to use a solicitor, see our in depth guide on this here, and you will have to pay their legal fees. 

Always keep in mind the total cost of an arrangement and any hidden fees. Using a broker and taking legal advice will minimise any nasty surprises. 

What are the pros and cons of bridging loans?

Bridging loans can be a useful form of short-term finance that can be made available relatively quickly, however, in some circumstances other types of financial product may be better suited to your needs. Whilst bridging loans offer a great deal of flexibility they carry higher costs, a range of fees and require property as collateral for the loan.

If you don’t have a definite and short-term end date for your funding requirements then it’s advisable to think carefully about your options; bridging loans are designed for short repayment periods and lenders will expect clarity on an exit plan.

What alternatives are there to a bridging loan?

There are a range of alternative options to consider when looking for a loan. It’s recommended you speak to a specialist broker about your requirements so they can advise on the types of product, and lenders, that suit your circumstances.

Here we explore some of the most common alternatives to a bridging loan:

Mortgages

A mortgage is a long term loan secured on property. A bridging loan is not a type of mortgage although both products have similarities as they use property as collateral.

Mortgages are more appropriate for longer term needs and tend to come with lower interest rates, whereas bridging loans are short term arrangements. It is unlikely you would be able to get a mortgage on a property that needed substantial work or development, whereas bridging loans can be used for development purposes.

For a detailed breakdown, read our guide to bridging loans vs mortgages.

Buy-to-let mortgage

A buy-to-let mortgage is a loan is a type of finance used to purchase rental properties that will be let out to paying tenants. This type of mortgage typically has longer repayment terms than bridging loans and lower interest rates. 

The benefit of a buy-to-let mortgage is there is no need to sell your existing property to secure the loan, and the income from tenants will cover mortgage repayments on your investment. 

Remortgaging and equity

Remortgaging is a popular option and this involves switching to a new lender or renegotiating the terms of your loan with your existing lender.  

In some cases, the value of your property will have increased since you took the original mortgage giving you more equity, which is the amount your house is worth minus the amount you owe. Increasing your equity means that your mortgage lender may allow you to borrow more. Even if the value of your property hasn’t changed, it is worth discussing options with your mortgage lender as they may be able to offer some flexibility and potential options for you as an existing customer.

Second-charge mortgage

A second-charge mortgage is a loan secured on your property, it is separate from your main, or first, mortgage and funds are provided by a different lender.  As your property is used as collateral if you default on either mortgage your home could be repossessed.

Equity is important for a second-charge mortgage as lenders will want to make sure that if you defaulted on payments the sale of your property would cover both mortgages.

Equity release mortgages

Equity release mortgages are often synonymous with people of retirement age and you will need to be aged over 55 to qualify for this option.  This financial product allows homeowners to borrow money against the value of the property and continue to live in the property until it is sold. When the property is sold the loan will be repaid with interest.

Commercial mortgages

Commercial mortgages are a long-term financial product, with repayment terms up to 25 years, secured on a property that is not where you live.

Ordinarily commercial mortgage rates will be significantly lower than bridging loan rates, however, if you do decide to pay a mortgage back earlier than agreed there may be early repayment fees. If you would like the flexibility to pay your mortgage back earlier, or overpay, then speak to your mortgage broker to match you with a lender that offers early repayment options. 

Interest payments on commercial mortgages are tax deductible and so this can help reduce taxable income and, in turn, liabilities. 

Asset Loans

Asset loans describe a category of financial products and services that help businesses and individuals secure funding based on the value of their assets. Using assets as collateral negates the need for using property.

Often businesses use asset loans to buy or lease machinery and equipment needed for their operations. The lender provides the money upfront and the business pays the loan back over time in smaller, more manageable amounts.

A key benefit of this type of financing is that it preserves business cash flow, which is crucial for a variety of purposes such as investments, unexpected bills or tax liabilities. 

Personal or small business loans

Small business loans are one of the main finance options used by startups and small businesses. This type of loan is quite straightforward with funding provided by a lender, often a mainstream bank, that is paid back over an agreed period with interest. 

Unsecured and secured loans

Unsecured loans are a type of credit that isn’t based on assets such as property or stock. Lenders will assess the creditworthiness of a business and the likelihood that they will be able to pay back the loan. Unsecured loans are often shorter term arrangements.

This type of loan is considered to be higher risk as the lender does not have certainty the payments could be met, or that they will receive their money if the business defaults on the arrangement. Unsecured loans ordinarily have higher interest rates than secured loans.

Secured business loans are based on assets or ‘collateral’ so the lender will have confidence that monies can be recouped if the business defaults on payments. Often assets such as property, or merchandise are used to secure loans.

Interest rates on secured loans are often lower as there is a guarantee that the lender will get their money back; however, with long term secured loans interest rates can be higher as a lender is tying up funds for a long period.

Invoice finance and factoring

Invoice finance and factoring allows you to use your outstanding invoices to secure financing, typically 80-90% of monies due. Factoring is where a lender will pay you directly and take ownership of the invoices, they will collect the payment and settle any remaining amounts. With invoice factoring the lender will take a fee for providing the service or a percentage of the invoice amounts.

Development finance

Development finance loans are short to medium term loans designed for significant property refurbishments or developments,  and are based on the projected value of the completed works. This type of finance can be costly as it is often used for large and complex projects by property investors. 

Negotiating with an existing lender

If you’ve run into difficulties with your current mortgage provider and are in arrears, you may be asked to redeem your loan in full, or face the threat of repossession.

A bridging loan can be used to repay your mortgage, with the interest added to the loan, leaving you with no monthly repayments to make.

Many lenders will be keen to avoid last-resort actions and have specialist teams to help those in debt, with a range of options.  If you are experiencing difficulties then contact your lender as soon as possible to outline your situation.

Fast house buying companies

Fast house buying companies can be used to release equity from a property quickly. The key difference is bridging finance allows you retain ownership of the property, whereas quick house sale companies are purchasing the asset from you.

It is important to note that fast purchases companies usually offer no more than 75% of your property value, meaning they make a considerable profit on the property.