April 10, 2018
As a useful source of short-term capital, bridging loans are well known for offering a fast, temporary and interest-only funding solution. But everything else - such as when you’d use one, who bridging would suit, or how it works – is a little less clear.
There are therefore many common misconceptions out there.
So, to get you up to speed, let’s tackle these common questions around bridging finance, starting with the costs:
Like any loan, when thinking about expense, it is important to consider how much the overall cost will be for your client, depending on how long they intend to take to pay the loan back.
And here’s the key to understanding the costs of bridging. Unlike conventional mortgages, where the borrower is signing-up to something like a 25-year term and will often stay for 5-7 years with the same lender, regulated bridging loans are up to 12 months in term and normally paid-back in 7-9 months (and as little as a few days in some cases). Bridging loans over 12 months are unregulated.
Bridging operates in a fundamentally different way compared with regular mortgages and is essentially a type of large-scale ‘project financing’ loan, rather than funding to secure a long-term property.
Key to that is having very high levels of flexibility to pay the loan back at any time, as well as features like rolling interest into the loan so that cash outflows can be managed. It is also flexible in terms of the types of property that can be lent on.
For instance, a property with no kitchen or bathroom would be deemed “unmortgageable” by a mainstream mortgage lender, whereas a bridging lender would consider taking on the higher risk if the borrower has a credible exit strategy, such as refurbishing the property to a mortgageable standard, before refinancing.
The short-term nature means that bridging loans tend to have interest rates quoted on a monthly basis, not the annual interest rates of a regular mortgage. Though a rate of, say, 1% per month would be substantially higher than a 3, 4 or 5% per annum rate the client is in essence paying for the far higher levels of flexibility in the product – whether that’s the ability to repay or whether that’s the riskier types of property being lent on.
And, crucially, there are typically no Early Repayment Charges on a bridge. So when we take the overall cost into account, while the interest charges might be lower with a regular mortgage, exiting in the first year of a 5-year fixed deal would incur something like a 5% ERC. That could far outweigh the interest differential.
For example, with a bridging loan for £100,000 with an interest rate of 1% for each month of the loan, your client would be paying £1,000 just on monthly interest payments vs. a few hundred pounds on a regular mortgage. But, if they redeemed after 5 months, they would not face a £5,000 penalty that they would get if they had a 5% ERC. In that instance, the overall cost would be lower with a bridge.
Moreover, the real beauty of bridging is its ability to access capital, quickly, until a more permanent solution is found. So, its short-term purpose, if used well, can be maximise profit and potentially save money – which makes it a small expense in comparison to the potential of losing big, because a deal couldn’t otherwise be done. So when asking 'are bridging loans expensive?', we should consider the ‘opportunity cost’ of not using the bridge.
Here’s a real case example:
A recent bridging loan helped our client increase his property value by £600,000. Here’s how:
Our client’s property – a flat - was valued at £900,000. The lease had 22 years left and he would need to extend it to sell both easily, and profitably.
He needed to pay £300,000 to extend the lease, but due to the short lease left, he could not re-mortgage with the High Street to raise the money to pay for the extension.
So, he was recommended by a local broker to arrange a second charge bridging loan for £300,000 for two months, so he could extend the lease and then refinance. With the extended lease in place, our client was able to revisit the High Street lender for a re-mortgage of £620,000 against the new property value of £1.5 million.
His use of a bridge enabled a deal to go ahead that added £600,000 to the value of his property, for a cost of £300,000 and the interest costs of the bridge.
This is a common misconception of Bridging Finance, that maybe it’s only for clients with adverse credit or in an exceptional situation.
But bridging is actually used for everyday clients who have some need for quick, short-term capital. This could be anything from funding refurbishments, auction purchases, lease extensions or simply recovering a broken property chain.
Ultimately a Bridging loan a tool, just like any other form of property finance, that can be assessed as the most appropriate solution for your client under the right circumstances. Here are some typical uses of Bridging loans:
Although bridging finance has existed for quite a few years now, the marketplace is relatively young and some of the bridging lenders are fairly new - so, it’s not surprising if you are not familiar with many of them.
If you haven’t worked with a bridging lender before, you may not know much about the levels of professionalism to expect. So, let’s start by taking a quick take a look at that.
In terms of compliance and regulation, there is FCA regulation for some bridges, and many bridging lenders, including alternative non-bank lenders are actually FCA regulated entities. Many of these lenders are also members of the Association of Short Term Lenders, which means they have to abide by a strict code of conduct including disclosing all costs and fees up front, not charging excessive fees, read the full list here. The commitment to bodies such as the ASTL, has driven professional standards throughout the industry.
Also, as part of a rapidly growing marketplace, with higher demand, many bridging lenders are now competing to be the best. This has driven levels of customer service, lending and underwriting practices. Many bridging lenders often underwrite each case individually and offer customised solutions for each customer – which is just one example of how much care and effort is practised by these lenders.
As a professionalised market, many, especially property professionals have recognised and become confident in using bridging as short-term solution. This reflects in the strong growth of gross bridging lending which has grown from £1.7bn in 2013, to £5bn in 2017. You can find out more about the market activity in the West One Bridging Index.
As mentioned earlier, more demand for bridging loans has resulted in proliferation of lenders and the products available. So yes, it could be considered a little overwhelming – especially if it’s a financial area you’re new to.
Some lenders will do business directly with both individual borrowers and intermediaries, but others are only accessible via specialist bridging loan distributors. A specialist could save borrowers and brokers time researching through the many choices and help them find a product better suited to their needs specifically.
If you’re still not exactly sure what a bridging loan is, take a watch of this short video.
For a chat on bridging finance, a meeting to discuss opportunities, or just talk over that more complicated deal on your desk - give our experienced team a call today on 020 8731 5333 or drop us a line.