What Is A Bridging Loan?
Bridging loans are a form of short-term finance, aimed at ‘bridging a gap’ between a time when funds must be paid out and a later time when further funds are received to cover this expense. Bridging loans are typically used in connection with the purchase of property, though they can be taken out for other reasons. The terms associated with bridging loans are typically 12 months or less. There is some availability for loans of this nature to be taken out over a period of up to three years, in certain circumstances. Bridging loans are generally issued by specialist providers, who use different methods of underwriting to those of mortgage lenders or other loan providers. The decision to lend is often not affected by adverse credit ratings or low-income in the case of bridging loans, as it is based on the value of the asset used to secure the loan and the exit amount of an investment. In other words, if the loan is used to purchase an investment property that will be resold or refinanced quickly, the availability of the loan will depend on the amount that is expected to be made through the sale or refinancing.
In what circumstances can they be used?
Bridging loans have traditionally been used by people involved in a broken chain conveyance. A conveyancing chain is broken when the sale and purchase of any party involved in the chain are not ready to complete at the same time; either the sale is ready before the purchase, or vice versa. In some cases, the transaction that is ready to complete must go ahead independently of the linked transaction, as waiting for the related sale or purchase to reach the same stage of completion would result in a breakdown somewhere else in the chain. If it is necessary to complete on a purchase ahead of a sale, a bridging loan can be an invaluable source of finance. The loan provides funds to cover the purchase, allowing the transaction to complete, and can be repaid when the finds come through from the related sale. This is a great tool for investors who are developing a property portfolio or involved in flipping property. Should a great investment opportunity arise whilst an existing asset is still being renovated, the investor can purchase the new property using a bridging loan and pay this off when the existing property in their portfolio is renovated and sold.
More and more, bridging loans are being used by investors in cases where a property does not qualify for a mortgage or where it is being purchased for planned renovation. If a property is in a rundown state and needs a lot of work doing to it, it may not be possible for an investor to get a mortgage secured against it. For instance, if a property does not have a plumbed bathroom, it would be considered uninhabitable by mortgage lenders and a mortgage application would be rejected. Underwriting for mortgages is done on a check-box basis, meaning applications are rejected without question if they do not meet any one of a list of the required criteria. This means that plans to renovate the property (e.g. to build bathroom) would not be taken into consideration and the application would fail. Underwriting for bridging loans is generally done on a more bespoke and individual case basis. The lender would look at the plans for renovations, associated costs, the final value of the property and the investor’s exit strategy, making a decision based on these factors. This allows investors to use a bridging loan to purchase and renovate a property, which can then sold. If the investor would prefer to keep the renovated property and either reside in it or let it out, they will have the option to refinance with a mortgage lender, once the renovation work is complete.
Due to the underwriting for bridging loans being done on a case by case basis, relying only on the value of the property and planned exit strategy, it may be possible for an investor to successfully apply for a bridging loan, even if they cannot get a mortgage due to low credit score. A detailed plan would be necessary in this case, to convince the lender that the property is a sound investment. This provides a good alternative form of finance for those who may struggle to get a mortgage due to factors like self-employment, recent change in workplace, lack of savings or poor credit rating.
Bridging loans can be a fantastic resource for investors looking to buy properties at auction. Properties can be snapped up well below market value at auctions, as they are often repossession or distressed sales. However, once the hammer falls on an auction sale, things move very quickly and the full balance of the purchase price is usually required within 21 to 28 days. It can be difficult to get a mortgage offer approved in this time, even if lenders have been approached upfront. Bridging loans offer the advantage of flexibility and convenience. They can be arranged very quickly – often with funds being deposited within 24 hours of the application being approved. This means that a bridging loan can be used to pay the balance of the purchase and complete on the property in the required limited timescale, giving the investor time to arrange a mortgage and refinance the property at their leisure.
The final advantageous use that a bridging loan can be put to is to make you a cash buyer. Funds can be obtained upfront, before making an offer on a property. With funds from a bridging loan already in your account, you are effectively a cash buyer, even though the money is loaned. This can put investors in a powerful position to negotiate excellent purchase prices. Many sellers want to deal with cash buyers, as this can both speed up and simplify the conveyancing process. Once the purchase is completed using the funds from the bridging loan, the investor is again at liberty to arrange a mortgage and refinance the property.
Are there any risks?
The downside to bridging loan is the cost. The interest rates are typically high when worked out as an APR. This can be considered misleading though, as the high interest is balanced out by the short-term nature of the loans. The only time this is a real problem is if an investor misses their exit. If the investment fails, interest keeps increasing and investor must find money to repay the loan from some other source or lose the asset put up as security. Care should be taken to ensure the planned exit is as certain as possible before considering a bridging loan.