When you are looking to purchase a ripe piece of real estate but require cash inflow from the sale of another property that is dragging along, bridging loans can be the lifeline that keeps your investment plans on track.
A bridging loan is short-term finance designed to “bridge” a funding gap. This gap is often referred to as a “broken chain” where there exists a liquidity shortage due to a lag in the timeline of cash flow between selling and buying property. Bridging loans help fill this gap by providing the speed and certainty required in time-constrained real estate transactions. Below, we explain what bridging loans are, how they differ from traditional mortgages, the typical costs and structure of bridging loans, and how to use them when stuck in broken property chain.
What is a Bridging Loan and How do they Differ from a Traditional Mortgage?
A bridging loan is a fast, short-term facility (typically between 3 and 24 months) secured against property. The interest rate charged for a bridge is higher than a standard mortgage to account for the increased risk given the speed and flexibility it provides compared to the long-term stability of a traditional mortgage. Most bridging loans are structured as interest-only products, with interest either serviced monthly or rolled-up and repaid at the end of the loan term. The key differences between a bridging loan and traditional mortgage are centred around four key pillars – purpose, underwriting process, speed, and flexibility. The purpose of a bridging loan is to provide a solution for liquidity gaps, not to offer a long-term finance solution like a mortgage does. The underwriting process focuses on the value of the security and exit strategy of the borrower. The exit strategy is often the most scrutinized detail by lenders underwriting a bridging loan as they want certainty on repayment. In contrast, the underwriting process for standard mortgages focuses on long-term affordability and the income of the borrower. Bridging loans can be granted in a matter of days or weeks, a much faster process than traditional mortgages which can take months before drawdown. Bridging loans UK also offer a greater degree of flexibility to the borrower. If the lender feels comfortable with the exit strategy, they will often be willing to lend against multiple securities, non-standard properties, or complex structures.
Costs and Structure
Given the speed and flexibility offered by a bridging loan, their pricing adjusts accordingly and thus you should expect higher costs than traditional mortgages. The interest rate will typically be quoted on a per month basis due to the short-term nature of bridging loans. The arrangement fee will usually be between 1% and 2% of the gross loan amount and deducted from the facility before drawdown. You will also encounter legal, valuation, and admin fees that are payable to third parties or the lender. Some lenders may also charge an exit fee which is a percentage of the loan (typically between 1% and 2%) payable on redemption. Lastly, if you are transacting through a broker, you will likely need to pay broker fees. It is important to get clarity on their fee structure the moment you start engaging with them.
How to use a Bridge When Stuck in a Property Chain
When you need to acquire a property because it presents the perfect opportunity for investment or development that you have been looking for, but have a liquidity shortage, a bridging loan provides the perfect solution. To ensure successful use of the bridging loan, you need to follow a pragmatic approach to the transaction. First, you should clarify the timing gap and what is causing the cash flow shortage for example, confirming when exactly cash inflow is expected from the sale of another property. The next step is to identify the security for the loan, whether it is the property you intend to purchase, a different property, or multiple properties when looking to cross-collateralise. The next step, and possibly the most important, is establishing the exit strategy. This is often the part of a deal the lender is most concerned about. Common exit strategies for bridging loans are the sale of an existing property, sale of the security, or refinancing on to a longer-term facility. Ensure you present your exit strategy clearly to the lender and provide certainty, such as offering evidence of your refinance pathway or detailing the sales progress for an existing property or development. Once you have gathered the necessary information and documentation to present a credible case to lenders, you can obtain indicative terms, benchmark different options (preferably through a broker), and submit an application. You will then need to line up a valuation and get legal affairs in order. Try to book the valuation early and ensure your solicitor has experience in bridging loan transactions. Once the valuation comes back and the lender is happy, you can draw funds and coordinate the purchase with your solicitor and the relevant parties.
Why you Should use a Specialist
A seasoned broker who has established relationships with bridging lenders offers an invaluable service to secure the funding you need. The UK bridging market has become extremely saturated with many lenders competing for business through various product offerings to gain a competitive advantage. A broker helps you navigate the market with access to their vast network of bridging lenders. A broker can filter through the market and benchmark different options to ultimately source the bespoke and tailored funding package you need.
The bottom line is that when you think the investment or development opportunity you have been looking for is slipping away due to a shortage of funds, a bridging loan provides the speed, certainty, and flexibility required to make your purchase and extend your timeline.