The pros and cons of bridging loans for UK property investors

Bridging loans offer a short-term borrowing solution for property investors in a number of scenarios. In her latest column for What Mortgage, Michelle Niziol examines the pros and cons of this type of financing.

If you are a landlord, property developer or investor, you will have noticed that over the past decade or so (since the 2008 financial crash), many UK lenders have been hesitant to increase their exposure to property risk through issuing traditional mortgage agreements at the same level and frequency they used to beforehand.

This trend has only got worse over the past three years due to Brexit anxieties and will likely continue until after the UK has left the EU and our markets begin to stabilise again.

Essentially, until lenders have a clearer picture of the future of the UK economy, they will be hesitant to issue loans and mortgages that stretch beyond the next few years.

That being said, as lenders have been reducing their standard mortgages to property investors and developers, an alternative type of lending practice has grown in popularity to take its place.

Enter bridging loans: the short-term borrowing solution for property professionals, which allow them to continue their investment and development of the UK property market, while providing lenders with the security they need to feel safe in their mortgage agreements.

What is a Bridging Loan?

The primary difference between a bridging loan and a standard mortgage is its term length. A bridging loan is very short-term. While traditional loans can stretch up to 35 or even 40 years, standard bridging loans typically span one to 18 months, with the total loan amount repayable at the end of the term.

Bridging loans are normally used when it is not possible to finance the purchase of a property with a standard mortgage. It can be seen as a stopgap that enables investors to move forward before planning their exit strategy, which usually takes the form of remortgaging or selling their property.

There are two types of bridging loans:

Closed Bridging Loan

This type of loan is only applicable if there is a guaranteed exit in place, because long-term financing has already been arranged. This could take the form of an eager buyer for the property once it has been purchased and renovated, or a lender who has already agreed to offer a standard mortgage upon the loan’s completion. Because such property financing deals often all though, these types of loans are far less common.

Open Bridging Loan

This loan is used when there isn’t a definite exit date for the lender because long term finance isn’t in place. As such, this type of bridging loan is far more common.

Do bridging loans seem like the answer for you? That may be true! But before you call your local lender to set up a bridging loan appointment, there are distinct benefits and risks which you will need to understand first.

Pros

1. Bridging loans are quick to arrange

As of now, bridging loans for investment properties are unregulated by the UK government, meaning lenders can be extremely fast in their loan approval process, compared to most other forms of financing. Without the same level of regulation, lenders are swift, agile and competitive in how quickly they issue financing. For property deals that are timely in nature, the speed of this financing can make all the difference.

2. Monthly repayment options

Unlike standard mortgage agreements, investors can decide to add their monthly interest payments to the final payment. This means there would be no repayments to make during the term of the loan. For example, this can be advantageous to investors who need the loan to purchase and renovate a property for sale, while not having any income until the sale is complete.

3. Available for a wide range of purposes

While traditional mortgages are generally only available for inhabitable property, bridging loans are applicable to many types of purposes; including land deals, renovations and construction projects where nothing has yet been built.

4. Can be arranged as a secondary charge

For traditional mortgages, the lender has the first call on any funds that come from the property sale. This is called the “first charge” and is typically non-negotiable. Bridging loans on the other hand can be approved as a second or even third charge.

This means that lenders will still issue bridging loans on properties and investments that already have financing in place.

5. Less stringent on borrower credit ratings

Standard mortgages require verifiable security and an excellent credit rating. Bridging loans however, often place the focus upon the potential profitability of the development deal instead of the financial situation of the borrower. This is called a “Non Status Bridging Loan” and hence are available to borrowers whose credit scores may disqualify them from other types of financing.

6. No early exit fees

The majority of bridging lenders choose to make their profit though interest rates and arrangement fees. This prevents borrowers from having to pay expensive exit fees should there be early repayment. For example, if you took out a bridging loan for 18 months to renovate and flip a property but you ended up doing it in 6, you can repay the loan in its entirety without suffering any additional fees.

7. Can be financed up to 100%

A small group of specialist lenders offer 100% Bridging Loans, assuming sufficient security is in place. This opens up financing options to borrowers who would have zero chance of being approved for a traditional mortgage.

Cons

1. High interest rates

Standard bridging loans charge approximately 1-1.5% a month in interest for an open bridge, which works out to between 12.68% and 19.5% APR (annually). If you compare this to traditional mortgage rates of 5% APR, it becomes clear how much more costly it is.

2. Increased fees

Fees for bridging loans can be a good deal more expensive than their traditional counterparts. Borrowers will typically have to pay an arrangement fee of around 1.5% which will be added to the loan amount. Broker fees, valuation fees and sometimes legal fees must also be paid and can differ greatly between vendors.

3. Currently unregulated for investment purchases

Bridging loans for properties which borrows reside in do come with regulations and protections similar to traditional mortgages, however bridging loans for property investments are not. While this does speed up the mortgage approval process, it also means borrowers have no recourse through the protection of the Financial Conduct Authority (FCA).

4. Widely varying lending rates and terms

Unlike traditional mortgages which offer very similar rates between lenders; there can be a significant difference in rates and terms between separate lenders of bridging loans. In addition, some lenders can only be accessed through a limited number of brokers, meaning you may not be able to access the lowest rates even if you did your due diligence.

As such, before you enter into any bridging loan agreement, you should check with at least 4 to 5 different providers to give yourself the best chance at securing the best deal you can.

Now that we’ve analysed the benefits and consequences of acquiring your bridging loan, you are in a position to make an informed decision on whether bridging loans are right for you.

Happy investing!

Michelle Niziol is CEO of the IMS Property Group and Michelle Niziol Ltd