When it comes to financing your property investment, a mortgage might be the obvious choice, but it’s not always the right one. Sometimes you have to complete a sale quickly or traditional mortgage products are not available for the property you have your eye on. In these cases, you need to source alternative financing for your investment quickly, and a bridging loan is an excellent option.
In today’s article, we’ll take a good look at what getting a bridging loan entails and signs it might be the right form of financing for you. We’ll also compare it to development finance, another alternative for making your property investment plans a reality.
What is bridging finance?
As its name suggests, bridging finance helps to “bridge” a financial gap when you’re purchasing a property. It helps you complete the sale on a property you have your eye on in situations where you can’t get a mortgage or don’t have the time to get one. It’s a short-term, property-backed form of finance: you’ll usually borrow the money for 1-18 months. There are often no monthly payments you have to make, but rather, the total sum borrowed plus interest is payable at the end of the loan term.
The pros of bridging loans
Perhaps the biggest pro of a bridging loan is how quickly you can qualify for one, meaning it’s easier for you to acquire the investment property of your dreams if the clock is ticking. After all, losing out on a property you love because you can’t get your finances together quickly enough is a very common heartache among people buying a new home or an investment property.
While a mortgage may take 18-40 days to approve (or even longer if there are complicating factors), your bridging loan application will usually be processed in 5-14 days. This means a bridging loan might be the right option for you in situations where you need to move fast. Bridging finance could also be your best bet in situations where you don’t qualify for a traditional mortgage product at the time of purchase – more on this later.
It is also worth pointing out, however, that although a bridging loan can be formally offered by a bridging lender within a short time-frame, people often forget that they still require a solicitor to complete the conveyancing on the deal after the offer is made. Because of this, you need to be careful when choosing your solicitor to make sure they have adequate experience when handling bridging finance conveyancing. This will ensure the financing comes through quickly.
The cons of bridging loans
When you opt for bridging finance, you need a strong repayment plan to cover yourself. If you’re planning on “flipping” a property – renovating it and then selling it for profit – selling the property at the end of your loan term would be a valid repayment policy – just make sure you have enough time to make the renovations, find a buyer and complete the sale. Acquiring a mortgage during the loan term can also count as your repayment plan.
As the loan terms are short with bridging finance, you don’t have much time to get the money together, especially if that money is dependent on something like renovations or the sale of the property, both of which can often be delayed due to unforeseen circumstances. Failure to pay back the sum borrowed at the end of your loan term would eventually lead to repossession and likely some high fees.
And while bridging loans are now cheaper than ever, with interest rates starting as low as 0.37% per month, traditional mortgages are still more affordable on the whole. Additionally, the fees associated with bridging finance are also high, including facility and exit fees that could, when combined, be as much as 3% of the total sum borrowed, as well as fees associated with the valuation of the property, brokerage and lawyers. So, if you’re choosing a bridging loan, make sure you consider the total sum payable, not just the interest rate.
Bridging loans also tend to require a lower loan-to-value ratio than mortgages do: while you could get something as high as a 95% LTV mortgage, typically with bridging finance, you’ll need to put down at least a 20-30% deposit to qualify for a loan like this.
When can you use bridging finance
As we mentioned above, bridging finance is a good option in cases where you need to complete a sale quickly or where a traditional mortgage isn’t an option – yet. If you’re purchasing a property through auction, you’ll usually need to complete the sale within 28 days of your winning bet. This doesn’t leave much time for you to get a mortgage together, especially if there are any complicating factors. In these cases, a bridging loan might be your best bet.
A bridging loan can also be useful when purchasing property under the market value. This is because lending is often based on the full market value of the property, meaning you could, in theory, purchase the property without a deposit. Bridging finance can also be used to purchase a property that doesn’t qualify for a mortgage at the time of purchase, such as one that isn’t inhabitable.
Another common scenario where a bridging loan may be your best option is when your deposit is tied up in another property – either your current home when you’re looking to purchase a new one or an existing property within your investment portfolio that you want to swap for another one.
Bridging finance vs. development finance
If the investment property you have your eye on could use some modernisation or isn’t at a liveable standard at present, a bridging loan might not be your only option: development finance could also work.
The most obvious difference between the two is their primary use: while bridging finance is used for purchasing property, development finance is most commonly used to cover light to heavy refurbishment or renovation of a property the applicant already owns to increase its resale value or to make it more liveable for buy-to-let purposes.
Development finance can also be used for new build projects where the money is spent in part for purchasing land and in part to construct new buildings. Development finance can be used to cover up to 70% of the land cost and up to 100% of the renovation costs. Your “Loan-To-Value” ratio will depend on how experienced you are as a developer. Once the lending is in place, a surveyor can make periodic checks into the process of your development and then request your chosen lender to release funds to you part by part.
If your investment property is in good condition, bridging finance is the right option for you when a mortgage is not available fast enough, and if the property needs some TLC, either bridging finance or development finance could be right for you. Development finance offers longer terms than bridging loans, making it the superior option for bigger development projects. However, interest rates are much higher, typically within the 4-15% range per annum. Additionally, there are monitoring fees to pay.
The financing option that’s best for you – a bridging loan, development finance or a buy-to-let mortgage – varies on a number of factors: the size of your deposit, your plan for your investment property, its condition and how you plan on purchasing it. If you’re unsure what the best option for you is, get in touch with our property investment experts for a non-committal discussion.
Here at Cox & Co, we offer a turn-key approach to property investment in Edinburgh and right across Scotland’s central belt. We take the time to educate our clients while qualifying them as investors. We then source the right investments that suit their requirements, advise and arrange all required lending, oversee the purchase process from start to finish and then manage the property from day one with as much care as if it was our own!