What To Consider Before Getting a Bridging Loan
The main thing to consider when applying for a bridging loan is that you have a clear exit strategy before taking on such a debt.
Bridging loans offer a fast and effective way to purchase a property, without needing a mortgage and can act as a viable growth tool for property developers and developers.
However, a bridging loan will always be secured against the property in question and not having a clear exit plan or a clear indication on costs can incur late fees, penalties and the property being repossessed by the lender.
If you have a clear understanding of your costs and timelines and can exit effectively, you may find that bridging finance is highly successful and scalable as a developer or investor.
The main things to consider before applying are:
- The risks
- The terms of the loan
- Costs and timelines
- Repayment terms
- Your exit strategy
- Finding the best rates
- Considering alternatives
1. What Are The Risks With Bridging Loans?
The main risks with bridging loans is that you might incur added fees and penalties that are if you cannot repay on time and your property could be repossessed by the lender as a worse case scenario.
For most bridging loans, the interest is rolled up and paid at the end of the loan term, which might be after 12, 18 or 24 months.
If not repaid in full at this point or at least partially at this point, you may incur a default interest rate which is usually higher than the standard interest rate charged. For instance, if the original rate of interest is 1% per month, the default interest rate might be 2% per month.
The lender may also issue late payment charges and an account review fee – which you are obligated to pay as part of your loan agreement.
Other severe consequences may involve the lender taking you to court, repossessing your property completely and having a negative impact on your credit score.
2. What Are The Terms of a Bridging Loan?
The terms of a bridging loan usually involve receiving the entire loan sum upfront (such as £300,000 or £500,000) and this allows you to become a cash buyer to go and purchase the property you have in mind.
The loan term is usually around 12-24 months depending on the lender and type of loan and the interest is usually rolled up and repaid in full at the end of the loan date, or upon exit of property.
The interest rate charged varies from lender-to-lender but is around 1% per month rate. The interest rate may vary on numerous factors such as the experience of the customer, their opportunity, the condition of the property, its location, the duration of the loan, the proposed risk and more.
3. What Are The Costs and Timelines Of Your Project?
Understanding the costs and timelines of your bridging loan project is key. Very often, developers use bridging finance to purchase a property and then carry out renovation work so that the value of the property will increase and can be sold on the open market for a higher price or rented out to tenants for a premium.
When purchasing a property and carrying out light or heavy refurbishment work, there are various costs and timelines to be considered relating to builders and the proposed sale of the property. By the time that you are making an application, you would like to have your building contractor ready and an indication of how much the building work will cost.
Being able to manage all the costs, unexpected costs and building delays is vital for the success of the project.
A good developer has a firm understanding of these numbers and factors and can present them very clearly to a lender when they are considering a bridging loan.
The ability to complete the purchase, building work and sale in both a cost-effective way and before the end of loan term is essential to maximise profits.
The costs to consider for a bridging loan project include:
- Stamp duty
- Solicitor fees
- Broker fees
- Survey and valuation fees
- Land registry and searches
- Building work, renovations, utilities, finishes, decorating
- Home upgrades such as energy efficiency
- Snagging
- Buildings insurance
- Unexpected building works
- Contingencies
4. What Are The Repayment Terms For a Bridging Loan?
There are different options when it comes to repaying a bridging loan, but most loans are repaid in one lump sum within one year or at the end of the loan term.
The repayment terms may depend on the project and the lender you work with.
As a rule, there are open bridging loans which do not have a fixed repayment date (although repayment within a year is expected) and there are closed bridging loans that have a fixed repayment date (such as 12 months or 18 months time).
The cost of your loan is based on interest that accrues, usually from 1% per month, so the longer the term of your loan, the more interest you will pay overall.
Understandably, if you can repay your loan early, you may accrue less interest and the overall loan will be cheaper.
An early exit fee may apply if you choose to exit very early and before the stated redemption period.
The interest is charged monthly and is based on the rates of the lender and the Bank of England base rate.
Your deposit and LTV ratio will impact the interest rate you pay. If you pay a larger deposit (lower LTV ratio), you are taking on more risk and will typically pay a lower interest rate.
5. What Are The Exit Strategies For a Bridging Loan?
Having a clear exit strategy from day one is essential when you are considering and applying for a bridging loan. During the application process, the lender or broker will want to see very clear evidence of this and expect some very professional plans which might include designs, drawings, cost forecasts and timescales.
The main exit strategies are:
Selling the property – Also known as ‘flipping the property,’ you use a bridging loan to purchase the property, carry out upgrades and improvements and sell this on for a higher price. This could be a residential or commercial property, whether it is a home, block of flats or office space.
Renting out to tenants – Bridging loans are often used to buy and refurbish properties that can be rented out to tenants, both residential and commercial. Upon exit, you might look to convert your bridging loan into a buy-to-let mortgage or other type of finance.
Refinancing – Bridging loans are very commonly refinanced under new terms or different terms upon completion. This could be moving the bridging loan to a more longer-term mortgage or different type of finance to accommodate your needs.
Business income – If you are using bridging for business and growth purposes and can generate income and revenue, this can simply be used to repay the loan.
6. Have You Found The Best Rates For Bridging Finance?
When considering a bridging loan, it is important to do your research and find the best rates and terms for your particular project.
Every type of project that uses bridging is unique and you may be able to access lower interest rates or higher LTVs depending on who you choose to work with. This difference could be worth significant sums down the line.
Using a bridging loan broker can help you get access to competitive rates from multiple lenders and allow you to compare different lenders and the options that you have.
Certainly paying a higher deposit will often give you much lower interest rates and weighing this up could be very important.
7. Have You Considered Bridging Loan Alternatives?
It is important to understand the risks and also opportunities with bridging loans. If you have not used one before, it is worth looking and considering all the different alternatives.
This could involve coming up with the capital you need through a personal loan, private investor, second charge loan or a traditional mortgage – or perhaps a combination of these things.
If you are only looking at making home renovations, you could look at products such as second charge loans or remortgaging to release equity.
Although time is usually of the essence when it comes to getting the loan to buy a property, it is important to consider all the different alternatives and the interest rates, fees and flexibility that they offer.