Bridging Loans

Categories: Conveyancing, News, Property

What are bridging loans?

Bridging loans – also known as bridge financing or gap financing – are short-term funding solutions that bridge the gap between the purchase of a new property and the sale of an existing property.

They ensure developers can move quickly to secure and develop properties. They are also used by real estate investors looking to acquire funds quickly to purchase a property before obtaining later finance, as well as homeowners who want to buy a new property before selling their current property.

They are usually offered for short periods, from a few weeks to a year. 

Why should property developers consider a bridging loan? 

Ther are some benefits, such as:

• Flexibility – they can be tailored to suit your specific needs.
• Speed – you can obtain the funds quickly.
• Cash flow – they help you to deal with the project management without having to wait for approvals for long-term loans or sales.

If you have a well-planned exit strategy, your lender may be willing to lend you more money. This includes if you have a robust plan for repaying the loan by the sale of a property or via refinancing. 

Related costs

There are some costs you must consider:

Equity

A bridging loan is usually based on the value of the property that is being used as collateral. Loan to Value (LTV) ratios tend to be about 70 to 75%. This means the equity in the property acts like a deposit in a mortgage arrangement. 

Upfront fees

It is common for several upfront costs to be associated with a property development bridging loan, including:

• Arrangement fees – typically 1-2% of the loan amount
• Valuation fees
• Legal fees
• Broker fees. 

Interest payments 

You may be required to pay interest monthly or the lender may “roll up” interest, which is paid at the end of the term. 

What are the risks of taking a bridging loan?

There are risks associated with bridging loans, so it is vital to take expert legal advice from a knowledgeable commercial property lawyer before obtaining one.

Interest rates

One of the biggest risks associated with bridging loans is the high interest rate, which is typically significantly higher than a traditional mortgage. This can make them more expensive in the long run. 

Repayment period

Another risk of bridging loans is the short repayment period. These loans are typically only for a term of a few weeks to a year, which means you must have a plan in place for how you will pay off the loan before the repayment period is up. 

If you cannot pay off the loan in the allotted time, you may face additional fees and penalties. There is also the risk that the lender will look to take possession of the property or land.

Deposit

Bridging loans typically require a higher deposit than traditional mortgages. This means you will have to have a significant amount of cash to qualify for the loan and you will have to have a good credit score to qualify.

These types of loans are secured against the property being purchased. This means if you are unable to repay the loan, the lender may be able to seize the property. 

Many lenders ask for personal guarantees as well as the charge against the property. This means, your personal assets, such as cars, houses and other items are at risk of being seized should you fail to make the required repayment.

Exit strategy

It is essential you have in place an exit strategy and understand what could happen if your exit strategy fails. Unless you know for sure that you can repay the loan at the end of the term whether your exit strategy succeeds or not should be fundamental to considering whether you proceed.

Are there alternatives to bridging loans?

If you decide that a bridging loan is not for you, there are other finance options to consider, depending on your specific situation.

Development finance

Usually used for larger construction projects, development finance is typically released in stages at each stage of the development. While larger sums may be offered at lower interest rates, it is a longer process and can have more stringent processes to get approval.

Mezzanine finance

Another higher cost financing option, it combines debt and equity financing. The finance is secured against the property.

Peer-to-peer (P2P) lending

This is an option for borrowing from individual investors and is an increasingly common way to obtain funding. The UK P2P lending platforms industry was about £376.6 million in 2023 – up 1.6% from 2022. This alternative source is often be quicker to arrange than traditional bank financing, but be mindful the interest rates.

Angel Investors 

An angel investor invests their own money in exchange for a minority stake – often between 10% and 25%). Angels can also offer mentoring and support, and will take a hands-on approach. 

Equity investment means your company will not need to repay back any funds or pay interest on the capital borrowed because an angel investment is a sale process and not a loan process.

Venture Capital

Venture capitalists invest money into businesses on behalf of a risk capital company. Expect more due diligence with an in-depth investigation into your business model and financial situation.