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How Does a Bridge Loan Work?
Bridging loans are arranged for a set term, usually between 1-18 months, with the loan repayable in full at the end of the term. The full interest is often deducted upfront, meaning there are often no monthly payments to make during the term of the loan.
In theory two types of bridging loan – open and closed loans. Open bridging loans have no fixed term and as such interest can’t be deducted as it is an unknown amount. Closed bridging loans have a set loan term and as such, it is easy to calculate the maximum total interest cost and deduct upfront.
Open bridging loans are usually more expensive, and you will need to prove that you can afford the monthly interest costs. As such, the underwriting process tends to be more complex, with the lender requiring more information. This may result in your loan taking longer to complete.
Closed bridging loans represent a much lower risk as there are no monthly repayments to be made and as such, they are usually the better option.
Regardless of the type of loan chosen, a solid repayment strategy is vitally important to reduce the risk taken.
Reasons to Get a Bridging Loan
Bridging loans can allow you to complete an urgent transaction which you would otherwise be able to undertake. Bridging loans are usually a tool that allows you to undertake a beneficial transaction or avoid missing out on a transaction.
Bridging loans in themselves, much like a mortgage don’t directly benefit you – they do allow you to complete a transaction that would otherwise be out of reach.
Read on below to find out the common uses for bridging loans and how they could benefit you.
What Can I Use a Bridging Loan For?
Bridging finance can be used in several situations. The most common uses are:
- To fund a property purchase or refinance quickly
- To purchase a property at auction
- To purchase an otherwise unmortgageable property
- To buy a property before your existing property has sold
- To buy an undervalue property without putting down a deposit
- To fund a property refurbishment project
- To finance property or land while undertaking an application for planning permission
The Pros and Cons of Bridging Loans
Bridging loans are a borrowing tool that is growing in popularity. Before taking out bridging finance, you should always be aware of both the pros and cons.
- Speed – Bridging loans can be arranged very quickly, with applications usually completing in 5-14 days, with some even completing on the day of application!
- Rates are falling – The bridging finance market is currently in a rate war. Bridging loan rates now start from 0.44%, with a rate of 0.37% available for select applications. The main drawback has historically been cost, although this is now becoming a definite pro!
- Flexibility – Bridging finance can be repaid early without penalty. When bridging loans are repaid early, any unused interest is usually rebated, saving you money.
- No monthly payments – Where interest is rolled up or deducted, there are no monthly payments to make. This can be a major help to cashflow during a refurbishment or marketing period.
- They allow lending against unmortgageable properties – Loans be used to purchase properties that you would otherwise be unable to borrow against.
- They add cost to a property transaction – No matter how cheap your bridging loan is, it will still cost something. This will add a cost to your property transaction that must be considered.
- Hidden charges – Comparing quotes from bridging loan lenders or brokers can be difficult. On top of the lender arrangement fee and interest rate, many lenders will charge additional ‘fund management’, ‘application’, ‘inspection’ or other fees. These can add up and mean that the lowest rate isn’t always the best option. You must consider the total cost of the loan rather than just the headline figures when comparing products.
- Problems with exit route – If you have problems with your method of repaying your bridging loan, this can cause major issues as the end of the loan approaches. If you are unable to repay the loan at the end of the loan term, you will have to refinance or service the loan, although there is no guarantee your lender would allow you to do either. This can put your property and credit profile at serious risk.
Who Would Qualify for a Bridging Loan?
There is fierce competition between bridging loan lenders, with more lenders opening their doors every day. As such, there is a lender for almost every situation. Poor credit history is usually not a barrier, your income isn’t always important.
If you own a property or land, have a realistic way of repaying the loan and have sufficient equity then there is a very good chance that you will be eligible for a bridging loan.
How Much Does a Bridging Loan Cost?
The costs of taking out a bridging loan are largely made up of the interest charges and arrangement fees. Monthly interest rates start at 0.43% per month but can be as high as 1.5% per month. The rate charged will depend on your circumstances and what you’re looking to do.
Lenders tend to charge an arrangement fee, usually 2% of the loan. For some larger loans, the arrangement fee may be reduced and can come in as low as 1% in some cases.
On top of the interest and fees, there may be other charges, such as asset management fees, exit fees, legal fees, valuation fees. Some brokers will also charge broker fees, although we do not.
Some lenders also charge administration fees, usually £295.
If you’re able to repay your loan before the end of the term, you will usually have any unused interest deducted from your redemption figure. This means that you only pay for the interest used.
Details of likely costs can be found on our bridging loan rates and fees page.
Are There Any Hidden Costs?
Although we always use reputable lenders, some lenders will add in additional fees. This can make comparing the costs of 2 lenders difficult. As such, always look at the total cost of borrowing when comparing 2 lenders, rather than just the arrangement fee and interest rates.
Another key hidden cost is the lender’s default interest rate. If the loan is not repaid on time, it is considered to be in default. Most lenders charge a responsible and fair interest rate in the event of default. Some see this as an opportunity to cash in, charging high default rates of 2-3% per month, sometimes charging it back to the start of the loan. You must check and compare default interest rates when comparing different loan offers.
Bridging Loan Interest Rates
Bridging loan rates start at 0.43% per month and are usually under 1% per month in most cases. Bridging loan rates are far lower than they were even a few years ago for most situations.
The interest payments are usually retained or deducted upfront and repaid with the loan at the end of the term, or before if your exit strategy comes to fruition sooner.
How Much Can I Borrow?
Unlike other forms of funding, your loan amount is generally restricted less by the borrower, and more by other factors, including the maximum LTV. The LTV is calculated by dividing the loan amount by the value of the property and multiplying it by 100.
For residential property, we can offer lending up to 80% LTV on a first charge loan and 70% on a second charge.
100% Bridging Loans – Borrow Up To 100% of the Purchase Price
100% bridging finance is short-term finance against a property with no cash deposit used towards the purchase. There are two main types of funding this, using another property or asset as extra security or buying undervalue, at say 70% of the open market value (OMV).
If a portfolio of repossessed properties valued on the open market at £1m were available to buy at £700,000, 100% of the purchase price (£700,000) would be available, in theory. Alternatively, if a client wanted to buy a property for £50,000 to renovate and sell and has no available cash deposit, he could, for example, use his own house or a buy to let property as extra security for the loan, assuming there is enough equity.
100% bridging loans usually work out at 70 – 75% of the open market value of a property. Although called 100% bridging loans, you can’t borrow 100% of the open market value unless there is another asset to use as extra security, this could be another property or a luxury asset such as a classic car.
Compare Bridging Loans
With so many new bridging finance lenders entering the market, and the differences in their pricing and fees, it’s becoming more difficult to find the best deal. That’s why we’ve built an easy-to-use comparison tool, so you can easily read through the latest market-leading products and use our bridging loan calculator to work out your likely costs.
Remember that you shouldn’t base your decision on rate alone, all fees must be considered. It’s often cheaper to choose a product with a higher monthly interest rate if the fees are lower.
Whether you want to compare rates online and calculate your costs or talk through your circumstances with an experienced advisor, we’ve got you covered. ABC Finance Ltd. can help you through the entire process from start to finish, making the process as simple as can be.