Here’s a bridging loan example premise for you. Let’s say that you’re in the process of selling your house. You know that you’re going to get money at the end of the transaction, but it will take some time.
In the meantime, another property has caught your fancy – and it looks like a great buy.
Unfortunately, you don’t have adequate finances for the purchase, so you worry that someone else will snap it up before you do.
Bridging Loans can help you in this case. A bridging loan is a gap fund to use when an individual or a corporation needs to purchase an item or pay for an obligation but is still waiting on the availability of funds from a previous or ongoing sale of real property or other assets.
What is a Bridging Loan?
A bridging loan is a short term loan you take out for a period that runs between two weeks to around two or three years. The payment term for a bridging loan depends on how soon one can secure larger or more long-term financing or a significant purchase such as that of real property or other assets.
It should be noted at this point that a bridging loan calls for a security deposit. In which case, you need to have a high-value asset that you can use as collateral to get a bridging loan. You can use any property or valuable asset as security for a bridging loan.
Bridging Loans Come in Different Types
In the United Kingdom, banks and other financial institutions usually offer any of the following bridging finance options:
Bridging Loans for Home Purchase
These are the most straightforward of the lot and are normally taken out against one’s property. Most of the time, these loans are used to purchase a property prior to the sale of one’s home, chain breaks, downsizing, the purchase of property in cases when one can’t get a regular mortgage, the purchase and development of investment or income property, as well as second-chance purchases. These may also be availed of if one gets rejected from getting a standard loan due to adverse credit or cannot earn a high enough income.
Bridging loans related to a home purchase fall into either one of two categories:
- Regulated Bridging Finance Loans which are secured against one’s existing property; these have a maximum term of twelve months, and the maximum loan to value is 75 per cent; or
- Unregulated Bridging Finance Loans are secured against a property that one doesn’t intend to live in, but plans to sell or refurbish as income-earning property like a leased flat. The maximum term can go as long as 36 months, also with 75 per cent maximum loan to value.
Regulated Bridging Finance falls under the jurisdiction of the Financial Conduct Authority.
Commercial Bridging Loans
Used for the purchase, refurbishment, and redevelopment of commercial property. Unlike bridge loans taken out for residential and income property, commercial bridging loans are meant to bridge the gap whilst awaiting tenants or getting the necessary experience to qualify as a commercial landlord. Qualifying for one means providing security, along with a valid exit strategy, as well as proof that at least 40 per cent of the property will be used for commercial purposes.
Residential Property Bridging Loans
Commonly used to repay related debts, purchase other properties for investment, and also make home improvements such as renovations. Payment terms for these loans run anywhere between a day to twelve months. Likewise, the value to loan may range between 75 per cent and 100 per cent with additional security.
Bridging Loan Example
Many banks and bridging finance companies usually offer a loan calculator on their websites to enable clients to get quotes in as little time as possible. But before you use these calculators, first understand what each item is in order to compute the correct loan amount and interest rate for your needs.
Bridging loan calculator
A standard bridging loan calculator would ask for the following items:
- Type, which refers to a standard (or outright) purchase, a refurbishment, or a second charge;
- The required term, which can run between one to 24 months;
- Number of Security Properties, to be used as collateral against the loan;
- Valuation of Security Properties Indicated;
- Net loan amount required, excluding broker fees and rolled payments;
- Broker Fees, if you’re using the services of a third-party broker;
- Lender Facility Fee/ Arrangement Fee;
- Assessment Fees;
- Telegraphic Transfer, the standard value for which is £35.00.
- Legal Fee; and
- Exit fee, charged when the loan is redeemed and can go from zero to 1% of the gross loan amount.
The type of bridge loan that you need, the payment term specified, the value of any property put up as security, and all stated fees will determine the total amount the institution is willing to loan you and how much you need to pay back.
Bridging Loan Example – How to Compute It
Say you’re a homeowner who wants to “trade up” and buy a new house but are waiting on selling your old one. To cover the costs of the new property until proceeds from selling the old one come through, you can take out a bridging loan from bridging finance companies. Here are some of the most popular lenders.
Below is a bridging loan example to illustrate what it might look like.
|Current property valuation:||£900,000|
|Outstanding mortgage on current property:||£200,000|
|New property valuation:||£600,000|
|New loan required (if the applicant has £200,000 cash):||£400,000|
Using the above scenario, we can cover the £400,000 deficit needed to buy the new property through a bridge loan. We work out the size of the loan by rolling the mortgages of two homes. To do this, we add the valuation of the new property to your existing mortgage and afterwards, subtract the prospective sale price of your existing property.
Ideally, a lower loan-to-value (LTV: computed as the percentage of the size of the loan against the value of all properties used as security) generates better interest rates on a bridge loan. Therefore, it’s better if the borrower uses more properties as security to lower the interest rate.
Calculating bridge loan cost using the above scenario:
|Net loan amount required:||£400,000|
|Facility fee (1.25%):||£5,000|
|Monthly interest rate @ 0.68%:||£2,754|
The gross loan represents the net loan required plus arrangement fees and the applicable interest for the chosen loan term. In the above bridging loan example, a preliminary computation of the gross loan is £407,754.
Should the property be purchased after 6 months, the first £400,000 representing the loan amount required, plus fees and interest rates will be utilised for the repayment of the bridge loan. In our bridging loan example, the balance from the same will be released to the borrower.
|Net Bridging Loan to be Repaid:||£400,000|
|Arrangement Fee/Facility Fee @ 1.25%:||£5,000|
|6 Months Interest @ 0.68%:||£16,524|
|Total to Repay:||£421,524|
|Balance to Borrower:||£478,476|
Using the above bridging loan example, the most cost-effective route is to have both properties used as security. Of course, you can opt to use only one property as collateral provided you do not go beyond the maximum LTV. Nevertheless, this would equate to higher monthly interest rates.
Bridging Finance Loan to Value Ratio (LTV)
LTV refers to the percentage of the loan plus outstanding mortgages measured against your equity. Therefore, if you own property worth £800,000, you’re eligible to borrow the amount £400,000 at 50% LTV.
In the above example, the percentage of loans + mortgages + fees (£607,754) measured against the value of the property (£900,000) computes to a 67.5% LTV.
A bridging loan calculator can cough up the LTV for you as well as the interest rate applicable.
Typically, a bridging loan interest rate is based on LTV.
|LTV||Montly interest rate|
|Up to 50%||0.45%|
|50% to 65%||0.58%|
|65% to 70%||0.68%|
|70% to 75%||0.78%|
Better monthly interest rates could be had at 50% LTV since rates increase for up to 70% with respect to regulated bridge financing and up to 75% with respect to unregulated bridge financing.
Bridging Loan Term – Which Should You Choose?
In our experience, it is best to arrange for a bridging loan for the full term (usually 12 months). Why do we advise this for bridging finance applicants?
Given fluctuations and uncertainty, paying a bridge loan under the longest term possible allows the borrower sufficient time for repayment, especially if there are issues with your first exit route.
However, some borrowers may find it more advantageous to opt for a lower term to get a higher net borrowing on ideal interest rates.
Even if a bridging loan for a 12-month term is taken out, the borrower will incur liability on interest for the period where the loan stands unpaid only.
Usually, monthly interest payments are not mandatory in bridging loans. Therefore, if you’re a borrower and you repay a loan that runs on a 12-month term only after 4 months and five days, interest attaches only for the period of the outstanding loan (4 months and five days plus arrangement and other fees).
Remember that the standard calculation of interest is daily after the first month.
For more information about bridging loans, click our FAQs section.
Bridging Loan Exit Strategy
In principle, most lenders will find any of the following situations as a viable exit strategy for those seeking to avail of bridging loans:
The borrower gains money from the sale of either the primary property or any property used as security and uses the earnings to repay the loan. This is considered the simplest and most practical strategy and is recommended by lenders and brokers;
- The borrower earns money to repay the loan from the sale of other properties or assets; or
- The borrower receives an inheritance that will enable them to repay the load.
- In practice, those applying for a bridging loan must present supporting documents for the exit strategy opted for. These include proofs of sale or, in the case of an inheritance, a copy of the will stating the bequest along with other probate documents.
Bridging Loan Example – Bridging Finance Case Studies
I. The Residential Purchase
A homebuyer is thinking of selling his home in the city and is seeking a home in a quiet country town to give his children a safer and healthier home environment.
When he does find a property, he finds that he needs to buy it as soon as possible. However, he has not – as yet – finalised the sale of his city house. Also, the seller is asking for a hefty down-payment to seal the deal.
As he had another property to use as security for a standard bridging loan, applying for and getting the loan should have been easy enough. However, it turns out that one of the properties did not meet the value required for a quick and low-cost valuation.
The homebuyer, in this case, stood to lose the house that he wanted if the property in question did not meet the requirements.
Unfortunately, getting an on-site valuation would have set him back by £300 [standard valuation fee] and, due to quarantine restrictions imposed during the pandemic, it would be difficult to get someone to head out and appraise the property.
The workaround, in this case, called for being vigilant about the property market. The algorithms used for online valuations can vary every week, depending on property sales within a particular area.
The homebuyer did a second online valuation and noted that the property value was within the required range. He got his loan within the week, and his exit strategy involved the sale of his city home within the next twelve months.
II. The Commercial Borrower
Unlike residential bridging loans that are straightforward, bridging loans for commercial purposes are slightly more complicated.
As with residential loans, bridging loans in the commercial context are taken out for various purposes, including – as stated above – enabling first-time landlords to skirt the requirement of minimum annual income demanded of more experienced property managers.
A first-time landlord is about to make his initial foray into renting out flats, but can’t get started because most lenders demand proof of an annual minimum income of £25,000 – which, being a total neophyte to the business, he doesn’t have.
The would-be landlord is referred to a company specialising in commercial bridging loans for those handling investment and income property.
The company went over his projected rent and noted that what he stood to earn was more than enough to repay the loan over a twelve-month-period. The company waived the annual income requirement and loaned 80 per cent of the required amount.