What is a bridging loan and how does it work?
What is a bridging loan?
A bridging loan is a short-term loan which is secured against property. Most bridging loans are arranged for a term of between one to 18 months to fund a specific need, with the property either being sold, or the loan refinanced onto a traditional mortgage at the end of the term.
Bridging finance isn’t usually a viable long-term financing product, as the interest rate charged is often higher than longer-term finance. Although this is the case, the cost of taking bridging finance is reducing as more lenders enter the market and competition between them intensifies.
Whereas a traditional mortgage will usually take four to six weeks to set up, bridging loans are far quicker, usually completing in one to two weeks. This is down to a far simpler application process than residential mortgages and buy to lets.
Interest rates are usually expressed as a monthly amount, rather than an annual rate, like with mortgages and personal loans. Although this can seem slightly confusing, it is due to the fact that many loans won’t run for a 12 month period, making an annual rate redundant. To work out the total cost of borrowing, the simplest method is to use a bridging loan calculator.
Bridging Loan Costs
The main charges associated with bridging finance are the arrangement fee and the monthly interest.
Most lenders will charge an arrangement fee of 2% for setting up the loan. The fee can be as much as 3% with some lenders, and occasionally as low as 1% for very large loans. The arrangement fee is usually added to the loan, meaning you don’t have to find the money upfront before completing on the loan.
The interest rate charged will vary depending on the level of risk involved in the application. The lower the perceived risk, the lower the rate.
The first factor in deciding the monthly interest rate is the type of security offered. Rates secured against residential properties tend to be lower, as they are perceived as the lowest risk. Rates will be slightly higher for commercial or semi-commercial property. Finally, rates secured only against land will have the highest rates as they are perceived as higher risk.
Secondly, the loan to value is a key factor in deciding the interest rate, with lower loan to value applications benefitting from lower rates. The maximum loan to value available will depend on your circumstances and the type of security offered.
Finally, credit history and your plans for the property can also play a role in reducing or increasing the rate charged.
The below table shows the maximum available loan to value (LTV), along with the lowest interest rates for each type of security.
|Security||Max LTV||Rates From|
|Land with Planning||65%||0.75%|
|Land Without Planning||50%||1.00%|
Most bridging loan lenders will give you the option of rolling up your monthly interest. This means the interest due is added to the loan, instead of being paid each month by the borrower.
The interest added is then repaid with the rest of the loan at the end of the term. This can benefit borrowers who would otherwise be unable to meet the monthly repayments.
Bridging Loan Example
Example IT Solutions are looking to purchase a new office for their business, which will allow the business to continue to grow. The property was purchased at auction and completion must take place within 28 days of the successful bid.
As this leaves them unable to complete a commercial mortgage application in this time, they have decided to take out a bridging loan. For the purposes of this example, the client is purchasing at £500,000 and is looking to borrow £250,000 – 50% loan to value.
As they will look to arrange a commercial mortgage to repay the loan, they would like a term of 6 months. This gives them adequate time to arrange the finance and allows a buffer for any delays in their commercial mortgage application.
After talking to a bridging loan broker, they have found a deal that they are happy with. The terms offered are 0.65% per month with a lender arrangement fee of 2% of the loan amount.
|0.65% interest (£1,625) x6 months||£9,750|
|2% Lender Arrangement Fee||£5,000|
They are looking to roll the interest up, meaning there are no payments to make until the loan is repaid. The lender arrangement fee will also be added to the loan.
At the end of the term, the client would repay the £250,000 plus any fees and interest that they had added to the loan. In this example, the figures would be as follows:
|Total to Repay||£264,750|
In the event of the loan being repaid earlier, the total to repay would reduce by £1,625 for each month saved.