A bridging loan can be defined as a type of short term property backed finance. They are mainly used to fund borrowers for a shorter time duration while allowing for refinancing a long-term debt or selling a property. Bridging loans are mostly offered across a time duration of 1-18 months. The principal (loan amount) is payable at the end of the period in full. The monthly interest cost.
Bridging Loans are particularly helpful when it comes to solving time property purchases, which might include properties bought at auctions, financial gaps when downsizing or upsizing, or securities that cannot be mortgaged. However, the overall amount that can be borrowed in such circumstances relies on a number of factors, which are mentioned below.
How Does a Bridging Loan work?
When a bridging loan is financed, the lender mostly takes over the mortgage, on the existing property, as well as the financing of the new feature. The amount that is borrowed in this regard is referred to as the peak debt and includes the balance on the existing property, the contract purchase price of the new property and further includes all the additional costs that might be required to complete the purchase process. Examples of such expenses include stamp duty, legal fees as well as lender fees.
As far as the repayments are concerned, it can be seen that the minimum repayments on the bridging loan are computed on an interest-only basis. This means that interest might be capitalized till the point when the existing property is sold off.
After the property has been sold off, the net proceeds of the sale are then used to reduce the Peak Debt. The remaining amount, referred to as the End Debt, is repaid as a consideration of a standard mortgage product beyond this point.
Factors Impacting the Amount That Can Be Borrowed.
Role of the Lender
This is a significant factor that determines the overall extent to which money can be borrowed. The purpose of the lender is essential in this case, mainly because of the reason that lender profiles are usually very well-diversified in terms of the amount they are willing to lend, and the charge they are ready to charge against it. As far as bridging loans are concerned, many lenders are prepared to offer bridging loans, if the application is correct and includes all the correct details. In this regard, a good property broker is most likely to have insights pertaining to lenders, in terms of the amount they are willing to lend, for the respective application. Therefore, they are going to approach the lender directly, and therefore, have the application processed.
Financial Position of the Borrower
Financial position and credit scores are critical when acquiring bridging loans. This also directly impacts the overall extent to which money can be borrowed for different circumstances. This provides the lenders with a security blanket, with regards to the overall ability of the borrower to honour their debts. In this regard, the role of the broker is also vital, because brokers are able to advise their borrowers on ideas relating to improving their credit scores, in addition to getting their outdated adverse credit issues fixed.
Valuation of the Underlying Asset
The underlying value of the property also tends to be one of the primary reasons that can influence the overall extent to which funding can be obtained. In this regard, a healthy practice is to hunt for lenders that opt for drive-by/desktop valuation, which is really helpful in speeding up the application process. Most lenders, understandable so, are fascinated by high valued properties, and therefore, this is directly correlated to the amount of credit that buyer is likely to extend.
Loan to Value Ratio
Loan to Value Ratio determines the overall attractiveness to the lenders because they are most fascinated with a lower ratio.
Property location is another factor that directly impacts the amount of lending that can be extended. As a matter of fact, properties located at a prime location are valued at a higher price, because they are able to secure a larger pool of funds since they appreciate with time, and therefore, the overall risk to return ratio tilts in favour of buyers.
Types of Bridging Loans
There are two main types of bridging loans, which are open bridging loans and closed bridging loans.
As far as a closed bridging loan is concerned, it can be seen that there is a fixed repayment date, and this loan is mainly applicable in the case where there are exchanged contracts, and the borrower is waiting for the property sale to finalise.
On the other hand, an open bridging loan does not have a fixed repayment date. However, this loan is typically repaid within a time interval of one year. Whichever loan that needs to be withdrawn, it can be seen that repayment strategies are a must-have for the investor, which might either be equity from a property sale, or a mortgage. Furthermore, they also require evidence of the new property that is being purchased, in addition to the expected price that is paid for the property itself. It is also an excellent strategy to have a back-up plan in the case where the repayment strategy fails to meet its desired objectives.
How much does a Bridging Loan Cost?
Bridging loans are prices on a monthly basis, as opposed to on an annual basis. This is mainly because of the fact that bridging loans are obtained for a shorter time period. However, they are quite expensive to purchase, and could possibly have an interest charge or around 0.5% to 1.5% per month. Therefore, this costing structure turns out to be costlier in comparison to a standard residential mortgage. The respective annual percentage rate on a bridging loan is between 6.1 to 19.6 %, which is higher than most mortgages.
Additionally, bridging loans are also subject to an additional fee of 2%, which increases its service cost even more.
What is the amount that can be borrowed with a bridging loan?
In terms of cash, it can be seen that bridging loans can provide lenders with an option to choose a disbursement ranging from £25,000 to over £25 million. However, the general rule of thumb that is followed in this case is mostly the fact that the borrowers can only borrow a maximum loan-to-value ratio (LTV) of 75% of the overall value of the property. Another contingency that impacts the borrowing amount is the fact that a first-charge loan has a more significant disbursement option as compared to a second charge loan.
Reasons to Opt for a Bridging Loan
There are two main reasons that can be used to justify opting for bridging loans. Firstly, it can be seen that there is an element of interest capitalisation. This means that in the case where the borrowers serving capacity is not sufficient enough to cover repayments on both properties, a bridging loan with interest capitalisation might help to provide breathing space that can ease the pressure till the time when the property is sold. Additionally, it is also rudimentary to realise that bridging loans can enable borrowers to borrow up to 100% of the purchase price of the new property, including the associated costs. In the case where the buyer has purchased a property outside of the current borrowing capacity, this can come in really handy.
Other secondary advantages of using a bridging loan are the fact that it makes it possible to save money, because of the reason that the client will then not have to pay for the service fees which must otherwise be reimbursed in the case where the mortgage of the first property is called off, and a new loan is taken off. In the same manner, the existing property can be sold unless the house is sold. In this manner, the rental fee can also be used to cover the part of debt until a potential suitor is found.
Therefore, it can be seen that bridging loans are particularly useful when money needs to be borrowed for a shorter time frame. This can help the buyer to bridge the gap, and enable the transaction, especially in the case where the buyer wants to purchase a property before selling off the old one. Furthermore, they can also be utilized in situations where properties are bought at an auction, and finance needs to be arranged for immediately.
This type of short term financing is beneficial, regardless of the incremental cost that is incurred in comparison to other financing mechanisms. It can also be seen that bridging loans, for a typical period of around 12 months, might be charged with 2-4 points. Loan to Value (LTV) ratios do not generally exceed 65% in case of commercial properties or 80% in case of residential properties in the case where this bridging loan is utilised.