Bridging Loans

What is a Bridging Loan?

A bridge loan is a form of short-term lending commonly used for property development and property purchases. The service is usually marketed by specialist lenders rather than banks. In many instances, the duration will be a few months but could be as long as a year or two.

Bridging loans can be categorised for their purpose, but the best difference to highlight is between an open bridging loan and a closed bridging loan.

An open bridging loan will have an open-ended loan repayment date whereas a closed bridging loan will have a defined repayment date. This distinction is an important one. Matching your lending requirement with a suitable lending resource is one of the most important debt decisions you will have to make.

Depending on your circumstances, a bridging loan may be the best option for purchasing property at auction, land for development, commercial property, or in some cases a residential property.

Typical characteristics and/or qualities of bridging loans can include:

  • Option for no monthly interest payments and no monthly capital payments
  • Can be suitable for individuals or businesses with bad credit or no credit history
  • Loan interest rates can vary quite widely. They can be fixed interest rate or variable interest rate
  • Suitable for time-sensitive opportunities

Bridging loan for property development

This is the textbook example of how to use a bridging loan and serves as a great illustration of matching the correct lending resource with the lending requirement. You can think of the lending requirement in two sections. The value of the loan and the length of time you require it (loan term).

The loan term should be for a period that suits your exit strategy. If you plan to purchase an unmortgageable property, renovate it, then refinance at a better rate, perhaps as a commercial mortgage, then a bridging loan would suit that requirement. Using bridging finance for this type of project does come with risks.

Any project with moving parts risks being subject to delays. Property development delays may become issues if you're unable to finish the project within the loan term.

This is where your skills as a property developer count. You need to make sure you have a back-up plan. A loan agreement that allows for some flexibility, without any punitive rates would assist you in this scenario.

If you think there is uncertainty around timings you should avoid using a closed-bridge loan. Even if your exit strategy is to develop, then refinance (at a lower rate), you may have difficulty refinancing. The perceived value of the property is likely to be less for a half-developed site.

In this example, an open-bridge loan will provide greater flexibility, but at a higher cost. Alternatively, you can use a closed-bridge loan, with a loan term suitably above the required duration, but that does not have early exit fees.

Second charge bridging loans

In this context, the term "charge" refers to the registration of a charge over security, by the lender, registered at companies house. A charge registered at companies house is sometimes referred to as a legal charge.

The charge will typically be secured against the property (a fixed charge) but can extend to other assets of the business (a floating charge).

A second charge bridging loan is a loan service targetted at Borrowers who already have a first charge loan registered against the asset (typically property or land).

Caution is advised when entering multiple loans. Particularly if multiple lenders are involved. Loan stacking will not be viewed favourably and can be risky but for this guide, I will not consider 2nd and 3rd charge bridging loans as evidence of loan stacking.

Fees for this type of loan service vary. All else being equal, you can expect 2nd charge bridging loans to be more expensive than first charge bridging loans. And third charge bridging loans to be more expensive than second charge bridging loans.

Generally speaking, the borrower would have used all of the first charge bridging loan facility. So, they are unable to leverage further on this facility. Second charge loans and third charges loans will then be subject to a lower loan to value ratio (LTV being the value of the property/value of debt) and therefore be riskier (from the Lenders perspective).

Due to the perceived increased risk, you may have to pay twice and or higher rates for the following:

  • A second valuation fee for a second valuation report
  • A second arrangement fee or set-up fee or Lender fee or facility fee (terminology differs)
  • A second broker fee
  • Additional solicitors fee
  • Higher loan interest rates

Quick bridging loans

There are advantages to fast access to a secured loan. Generally speaking, bridging loans are a pretty quick way to access short-term finance for projects with quick completion times. In some cases, you can expect offers in principle within days and funding with a few weeks.

Some reasons bridging loans are quicker compared to other business loans or even a residential mortgage include:

  • From a loan underwriting perspective, the Lender doesn't need to gain comfort on your financial performance, just the value of the property. Remember, there are typically no monthly payments with bridging finance. The interest and capital tend to be rolled up and paid at the end of the loan term.
  • Compared to testing credit history, affordability, security, employment status, and the usual lending criteria checks that are made, property valuation is relatively straightforward and quick. Once the property valuation is received by the lender they can quickly apply their LTV percentage to determine the maximum loan value.
  • Developers and property investors will often want to move rapidly on an opportunity. Common examples are auction purchases. This means there is a demand for quick secured loans so, the supply side fills the space. Rather than competing on price, bridging lenders are competing on speed and convenience.

If you're planning on acquiring an auction property you should consider getting approved terms from a Lender before the event.

Alternatives to bridging loans

In my opinion, there isn't an alternative to a bridging loan. There are other forms of finance, but they will be available for reasons specific to your circumstances.

We strongly recommend you take our "requirement and resource" approach when researching or preparing for any form of commercial finance.

Ask yourself "what is it the business and business owners require from the loan"? Create a list of the features and characteristics most suited for your business purposes. Then create a list of your limiting factors.

This list will not only help you chose the correct lending resource but may also help as a good planning tool for your project.

For example, if you've got a large unleveraged asset base and you're able to raise debt against that asset base, at a lower rate than bridging finance, why aren't you?

Alternative options to raise finance include:

  • A traditional mortgage
  • Leveraging other business assets- to raise asset finance or invoice finance
  • commercial mortgage
  • sale of property
  • personal loan
  • overdraft
  • a fixed-term loan

Bridging Loan Takeaways

Advantages of bridging finance include:

  • Quick completion
  • Suitable for uninhabitable properties
  • Cater for larger loans
  • Repayment options- matching cash outflow with cash inflow
  • Second charge attractive for some borrowers
  • A straightforward credit process which also allows for flexibility
  • Poor credit not always an issue
  • Can get a no early exit fee facility
  • Arguably, the best form of auction finance (dependant on circumstances)

Disadvantages include:

  • Bridging loan rates can be expensive. especially if you don't repay in time
  • Unregulated bridging loans may not be suitable for consumers
  • Need equity or will be expensive with limited options
  • Closed loans have drawbacks- particularly with operationally complex projects
  • Assumes your capable and well organised
  • You must have a viable exit route

There's a lot to like about this type of finance but, it does come with risks.

Bridging loans shouldn't be your first port of call when considering finance for your project but, there is an established market that understands the needs of the borrowers.