Among potential borrowers, there tends to be a lot of confusion between bridging loans and property development loans. It is true that there are number of similarities between the two products, however they are distinct offerings that have their own specific uses.
Common similarities that tend to be the root of the confusion are:
- They are short-term products.
- They are secured against property or land.
- They often have no monthly repayments.
- They are usually repaid through the sale or refinance of the security property or land.
In this article, we break down some key points about each product to help you to understand when each product should be used, and what you can expect from each.
When is bridging finance used?
Bridging loans are often used to complete property transactions that are urgent in nature and often to cover a short-term need. They can be used for the following purposes, among others:
- Buying a property before selling your current one.
- Funding a property refurbishment or conversion project.
- Financing auction purchases.
- Funding a property while it is sold.
Property refurbishment and conversion is often referred to by developers as property development, however they are seen as different things in the finance world.
Refurbishment and conversion involves making changes to an existing structure, and potentially even extending it significantly. This is a key distinction that we will discuss further in this article.
When is development finance used?
Property development finance is specifically used to fund property development projects. These projects are usually ground-up schemes, meaning they are building a property from scratch.
Property development finance is usually used only during the construction phase with the finished units usually being sold or refinanced once they have building control sign off.
How does the funds release process differ?
Bridging loan funds can be released in one of two ways. Firstly, the lender may choose to release all of the funds upfront. This approach is common for auction purchases and applications to fund property purchases before the sale of an existing property.
Where heavy refurbishment or property conversions are taking place, the lender may be willing to provide funding for the cost of the works to be completed. In this scenario, they are usually released in stages, as milestones in the project are reached.
The stage release approach is very similar to the funds release process for development finance, which is also stage released. An initial loan is made against the value of the site, with additional funds released to cover the build costs in stages throughout the build.
A key difference is that development finance lenders generally track progress using a quantity surveyor and focus on the work completed. Bridging loan lenders generally use a monitoring surveyor and focus on the amount of value added to the site since the last stage release.
How is the maximum loan calculated for each product?
Bridging finance is generally calculated based on the loan to value of the property. When releasing funds towards refurbishment works, they will usually also take into account the end value, known and the gross development value, or GDV.
Property development finance lenders use three metrics to calculate the maximum loan. The first being the loan to value of the project for the initial funds release. The second is the loan to GDV, as described above. Finally, the lender will use a metric known as loan to cost (LTC).
LTC describes the amount of loan available as a percentage of the total project cost. For example, a limit of 90% LTC would mean that you can borrow no more than 90% of the total cost of the project.
How long can I borrow for?
Both loans are generally a relatively short-term product, with terms for both usually ranging from a few months up to 18 months.
Both loans are generally governed by how long it is likely for the desired outcome to be completed – the scheme to be built out for development finance, and your exit strategy for bridging loans.
For larger scale property developments, the time taken to build all of the units will naturally be longer, so the loan is likely to be arranged over a longer term.
For both bridging and development finance, loans of up to 3 years can be offered where required and reasonable.
How does the pricing differ?
In both cases, the rates offered are governed by the perceived risk of the loan. Bridging loan rates are expressed monthly and rates of 0.43-0.65% per month are common. This works out to 5.16-7.8% per annum.
Development finance rates usually start at around 6.5% per annum and for relatively strong applications can go up to 9% per annum.
In both cases, the rates charged can increase sharply depending on the lender used, with rates as high as 15% per year relatively common.
How can bridging loans and development finance work together?
The biggest synergy between bridging and development finance can be found when refinancing a property development loan onto development exit finance.
This is usually done to either reduce the interest rate charged, release equity from a project, or both. Development exit finance is used to fund projects once they’re wind and watertight and is also known as sales period finance.