If you need to borrow money on a short-term basis, a bridging loan could be the solution. Also known as bridging finance, it can help to effectively ‘bridge’ the gap you may experience if buying a new property before you sell a current one.
We explore exactly what is involved with the bridge loan process and who they are most suitable for.
How bridge loans work
The two most common types of bridging loans are ‘open’ and ‘closed’.
Open bridging loans
With an open bridge loan, there is no set repayment date, but in most cases, you will need to pay off the total amount within 12 months.
Your broker will require proof that you have a repayment strategy, such as equity from the sale of your current property or taking out a mortgage. They will also want to see details on the property you are buying, including the price you plan to pay and evidence of the steps you are taking to sell your current property if you have one to sell.
Closed bridging loans
A closed bridging loan has a set repayment schedule according to the loan terms, which must be adhered to. This means both you and your broker will know the repayment plan and end date precisely.
You are most likely to be offered this type of bridge loan if you have exchanged contracts on your property, but the sale has yet to complete.
You can also opt for bridging loans for land over one to 24 months if you need bridge finance for time-critical land purchases and development.
Cost of a bridging loan
As bridging finance is short-term, interest is typically costed monthly rather than annually. And this means that one of the main downsides to bridging loans is that they tend to be more expensive than a regular property mortgage. With the average monthly interest ranging between 0.5% to 1.5%, the comparable yearly percentage rate, or APR, on a bridging loan is between 6% and 19%. This is significantly higher than most standard mortgages.
You also need to factor in the set-up fees, typically around 2% of the amount you wish to borrow. For these reasons, you should only consider a bridging loan if you know you only need it for a short and set period.
First and second charge bridging loans
When applying for a bridging loan, a ‘charge’ will also be placed on your property, depending on whether you still have a mortgage on the property or whether you own it outright. This assessment is required by the broker and is a legal agreement that determines which creditors will get repaid first if you default on your loan and cannot pay off your debt.
You will be offered a first charge loan if you own your property outright or you take out the bridging loan to clear off your existing mortgage. A first charge means that if you were unable to make your payments, the bridging loan would be repaid before anything else.
A bridging loan will be a second charge for properties with an outstanding mortgage. This means that if you default on payments and you sell your property to pay off your debts, the mortgage would be paid first, before the bridging loan.
How much you can borrow
When it comes to the amount you can borrow, it can be between £25,000 and £25 million when using bridging brokers such as Finbri. First charge loans are usually able to offer more cash than a second charge type bridging loan.
Alternatives to bridging loans
Bridging loans are not always the right solution, particularly if you need to move but don’t want to sell your property. In this case, a let-to-buy mortgage, where you remortgage your current property and use the released equity to buy a new property, may be the better option. Always seek professional advice to ensure you choose the right option for you.
