What is a Bridging Loan and How Much Do They Cost?
You may have heard the term ‘bridging loan’ being used more frequently in recent years. It’s now a popular and useful way to raise finance in a quick and easy manner. As brokers who arrange bridging loans, there are two questions we are most frequently asked. “What is a bridging loan?” and “How much does a bridging loan cost?”.
In this article, we will examine the benefits of a bridging loan, as well as look at the expected costs involved in obtaining a bridging loan.
Bridging Loans Explained
A bridging loan is a short-term form of finance, usually secured against one or more property assets which have sufficient equity in them. This type of loan is often used when speed and timing is of the essence and a bridging loan is put in place to literally “bridge the gap” until another longer-term form of finance is secured, or the asset is sold.
Another popular use of a bridging loan is when a property developer intends to purchase land or a property with the intention of increasing the value of the property or land by obtaining planning permission to develop, extend or convert.
There are two types of bridging loan, each secured against different types of property asset. A commercial bridging loan is secured against a commercial asset such as a shop, warehouse, mixed use property or a parcel of land that does not have planning permission.
Loan to value ratios are lower on these types of assets, with lenders typically lending up to 55%-60% of the property value.
Much more common are residential bridging loans which are secured against residential properties. This can include a main residence as well as buy to let properties. Lenders will typically lend up to 75% of the value of the property.
Costs Associated with Bridging Loans
The cost of a bridging loan can vary depending on the amount of finance needed as well as the length or term of the loan. Another important factor in the cost, is how quickly you will need to complete.
The interest rate on residential bridging loan can be anywhere between 0.45% per calendar month (5.40% per annum) up to 1.5% per calendar month (18% per annum) depending on the deal.
The lender will normally charge an arrangement fee, which is typically 2% of the gross loan amount. Some lenders will charge an exit fee although this is becoming less common with many lenders not charging any exit fees whatsoever.
The flexibility of a bridging loan allows for the term of the loan to vary. We often see a loan arranged for either 6, 9 or 12 months, however you will not be locked into this timeframe if you are ready to exit earlier. That said many lenders have a minimum term of 3 months.
One thing to note is that fees and interest are calculated at the start of the loan and usually retained by the lender, therefore they are deducted from the gross loan, leaving the net loan amount to come over to you.
The benefit of this arrangement is that the interest costs are allowed for ‘upfront’. This means that there are no monthly repayments required from you during the term of the bridging loan making it easier for you to manage cashflow.
So are there any other costs of a bridging loan? Yes there are. These include professional fees such as the cost of a valuation for each of the properties being used as security, along with legal fees. Bear in mind that you will be responsible for both your own legal fees and also the legal costs of the lender providing the bridging loan.
One thing to bear in mind. Due to the nature of bridging loans and the speed at which they often need to complete; having a good ‘commercially-minded’ property solicitor can make all the difference when it comes to getting these types of deals ‘over the line’.
When making an application for a bridging loan several other things to be aware of include the lender wanting to know the intended purpose of the bridging loan, and also the expected timeframe before the loan is repaid.
But perhaps most importantly, you need to have some idea of your proposed exit route. In other words, how you intend to repay the bridging loan back to the lender. So it is important that you have thought about this as part of applying for a bridging loan.
Benefits and considerations
There are many benefits to a bridging loan, not least that they can be used for a variety of purposes. One key benefit is speed. If you need finance in a hurry, then a bridging loans could well be the best option for you. There are several lenders who can make funds available in a matter of days.
Another benefit is that the barrier to entry is lower. In other words, unlike a mortgage or other long term finance product, there are fewer criteria that need to be met in order to obtain a bridging loan.
Also, the flexibility of a bridging loan means that you are not tied in for a long term and you have the flexibility of repaying early if you are able to do so, often without penalty.
As already mentioned, one important point to consider is your exit route. How will you repay the bridging loan? This is an important consideration for any lender, so you need to think about it ahead of time.
Bridging loans are an excellent short-term product for solving a specific issue. That may be a cash flow problem within your business, or it may be that you need to complete on a property purchase quickly.
Whatever the reason, a bridging loan is a useful funding option and could be the solution you need.