With property development always comes significant cost and covering this is the very first question that needs to be answered, whether the developer is completing their tenth build, or whether they’re cutting their teeth on their very first. There are property development loans available, which are suitable for some circumstances, but sometimes a different method of financing is necessary, and this is where bridging loans come into consideration.
What and why?
A bridging loan (see: https://brickflow.com/bridging-loans/) is one which allows you to borrow money on a short term basis. It is quite literally designed to ‘bridge’ any gap. For example, if you’re looking to buy a new home before you’ve sold the old one. Or for purchasing at auction where you’ll probably need the money if not immediately, then very quickly, and you haven’t sold your old house yet.
How do they work?
There are two types of bridging loan, an ‘open’ one and a ‘closed’ one. A closed loan is where you have an agreed repayment date, for example if you are waiting for a property sale to complete but you have exchanged contracts. An open loan is where there is no fixed repayment date, but it’s usually expected within a year.
Regardless of the type of loan, there are certain things which the lender will want to see evidenced:
- The new property you are buying.
- The sale of the old, if applicable.
- Your proposed repayment strategy, usually via equity from the sale of property or a mortgage.
It also goes without saying that a borrower needs a solid back-up plan in case the first repayment strategy fails.
Then comes the issue of the ‘charge’ of a bridging loans, split into ‘first charge’ and second ‘charge’.
A first charge means that this is a loan which, when you take it out, has a charge placed on the property. This means that there is a legal agreement in force which, in the event of a defaulted payment, means that the lenders will be repaid first.
A second charge is in the event of the property still being mortgaged, your repayments have failed and the house is sold to cover your debt, the mortgage providers will be repaid first.
Both types of charge will use your property as security in the case of default.
What can be expected in terms of the cost of a bridging loan?
This is a very broad question, and one to which there is no definitive answer because so much depends on the individual’s circumstances. What must be remembered is that this is a loan of convenience and therefore it’s going to be more costly than other types of finance. But taking a general viewpoint:
- It is a monthly cost that is calculated, not an annual one, due to the inherently short term nature of the loan.
- They are, for loans, an expensive option. Fees for a normal residential mortgage can come in between around 0.5% and 1.5%, give or take. The equivalent APR on bridging loans shoots up to usually somewhere around 6.1% to the astronomical (in comparison) 19.6%. This is obviously higher than many mortgages.
- 2% of the loan is put towards set up fees.
Due to the costs involved in a bridging loan, you need to think carefully about whether this is the right option for you. A high interest, short term loan isn’t one that most people would naturally want to go for, but if your situation dictates that you’ve got to consider something like this, then pay attention to the basics. It’s essential that you do your research, due diligence and – most importantly of all – crunch those numbers. Go through everything at least twice and if you can it’s a good idea to get the help if a professional. It’s only advisable to take out a bridging loan if you’re confident that it only needs to be a short-term thing and that you have a solid, reliable payment plan in place. Without this you may find that the costs stack up pretty quickly and could potentially threaten your development plans.
How much can I borrow?
Ah – the million-dollar question! There’s a big difference between how much you can borrow, and how much you should borrow. Bridging loans aren’t the ones if you suspect that you might have to borrow more than you technically need to. But as a general answer, bridging loans are normally between £25,000 and £25,000,000. The amount that you request should be based very carefully on accurate calculations which have been reached according to your personal circumstances. And the amount that will be given also depends on strict assessment criteria.
If we look at it in terms of your personal borrowing, the maximum loan to value ratio will be around 75% of your property value, which isn’t too unreasonable a figure. But again, it must be stressed that affordability is the key thing here. That’s what underpins all of the assessment criteria and the one thing that the lenders are looking to have set in stone. Which is understandable because who wants to lend money to someone who isn’t 100% sure that they can pay it back?
In terms of the charge upon the property, you will usually be able to borrow more if you have a first charge loan, rather than a second. And, again, it’s easy to see why lenders would prefer a more solid investment rather than one which is a bit looser and uncertain.
Are there any alternatives?
Absolutely. If you feel for whatever reason that the options above just aren’t going to work for you, or you won’t be eligible, then there are other routes you can go down. A buy-to-let mortgage, for example. This involves re-mortgaging your current home and then getting a buy-to-let mortgage with the equity that is released.
Again, there are plenty of options for both an experienced property developer and one that is new to the scene. The key here is to be realistic about what you want to build or refurbish – basically the property that you want to end up with – and along with that, what you can afford. Get these two in sync and the world is your oyster.