‘Bridging finance’ – it seems to divide investors. Some have had great success with it, while others are intimidated..
More often than not, the intimidation comes from a lack of understanding – that’s why we reckon there’s more education needed to be done with understanding bridging finance.
Investors, (experienced and inexperienced) need to know the pros and cons of bridging finance so they can decide if it’s for them or not.
But before that, let’s help you understand exactly what bridging finance is.
The easiest way for us to explain bridging finance is to describe it as “a short-term loan or mortgage”.
We know that description is a tad confusing. Mortgages are, by their very nature, long-term!
And bridging loans are quite similar to mortgages in many ways;
– The amount lent will be based on the property value
– Lenders take a “charge” over the property as security, in case you default on payments
– You’ll pay an agreed amount of interest during the loan period, then pay it all back at the end.
But there are some big differences, and as we’ve said, you need to think of bridging as a short-term mortgage.
With standard buy-to-let mortgages, you’ll usually take those out for 25 years or more. However, with bridging finance, your loan is only taken out over 12 months or less.
There are also higher costs associated with bridging finance. Repayments rates for mortgages are generally capped at 5% (right now at least), but the lowest rates for bridging is usually 8%, and can go up to 15% or higher.
Now you’ve got a clearer idea on what bridging finance is, we’ll move onto the pros and cons of using it, with a few different scenarios of where you can use it and benefit from it – and where it should be avoided.
Not always, but often, time is of the essence when investing in property.
A standard mortgage can take weeks or even months to be approved. And while this works if you’re buying a buy-to-let and are in the general purchase process, there are some instances when that delay simply won’t work.
For example: If you’re buying a property at an auction, you’re typically only given 28 days to stump up the cash.
Waiting for a standard mortgage to be approved won’t work, so you could turn to bridging finance to make sure you don’t miss out on the deal.
Or perhaps you’ve found a cracking deal where the vendor needs to sell the property as quickly as possible, even if it’s below market value – bridging finance could help you out.
You’d be in a better position if you could get the funds together quicker than a standard mortgage might allow..
This is another instance where bridging differs from a standard mortgage, and where it can really pay off.
With a standard buy-to-let mortgage, you can only borrow a certain amount based on what you’ve paid for a property.
So even if you’ve managed to get a below market value deal, you’re only going to be able to borrow up to 75% of what you’ve paid rather than the asking price.
With bridging finance, this isn’t always the case. Bridging lenders aren’t as fussed on being sticklers for the rules in this way.
Say you’ve found a property valued at £120,000 but only had to pay £80,000, you could still get the bridging loan of 75% of the £120,000 asking price.
You may not need that extra money, but it might free up some of the finances that you’ve been setting aside to refurbish a property, or simply to have as collateral.
If you’re smart, a major pro of bridging finance is making your money stretch further.
Some call it risk-taking, others call it being creative!
There are some situations where you simply cannot move forward if you’re not buying property in cash and require a mortgage.
For instance, if you find a property that’s going for a low price but is technically uninhabitable, you won’t get approved for a mortgage.
If it’s not got a working kitchen or a working bathroom, no lender will approve you for a mortgage – even if the problems are ones you can easily rectify without costing you too much.
But you guessed it, bridging finance does away with these restraints.
Your lender won’t need the property to be habitable before lending the money. So, you can purchase a real fixer-upper with bridging finance, make your refurbishments and sell on for an increase once it’s up to standard. This allows you to repay the original bridging finance quickly and hopefully pocket that profit.
Again, this isn’t necessarily a tactic we’d recommend to new investors, but if you’ve got the skills, the knowledge and the bravery to do it, it can pay off.
Now, for the cons…
Using bridging finance takes a higher level of confidence to really work for you.
If there’s even a slight chance you won’t be able to pay your loan back (including the higher interest rate), it’s best avoided.
As with mortgages, lenders will use the property as collateral so they can take it back should you default on your payments.
And while the shorter time-frame for repayment can work out well, as we’ve already covered, it’ll also makes things far tighter in terms of repayment dates.
Bridging finance shouldn’t be used if you’re only half-tied to an idea of how you want this investment to go.
If you’re planning on flipping, set the end date and be incredibly firm with yourself. Letting yourself fall behind on dates means falling behind on payments, which means more money out of your pocket.
It can be restricting to have yourself locked into an exit strategy, but if you’re smart with your money and strict with your completion dates, it can pay off for you.
Now, of course, this won’t matter if the deal you’re lining up is going to make you more money than you’re borrowing.
But it’s still worth remembering that you’ll be paying more for bridging finance than a standard mortgage.
Not only is the interest on repayments much higher (generally speaking, you’re looking at an 8%-15% rate), but you’re also going to have to pay higher rates in general.
The rates are usually about 2-3% of the borrowed amount.
So, make sure you’ve crunched the numbers in as much detail as possible before reaching out to lenders.
It should be clear from the pros and cons we’ve listed, but bridging finance really isn’t the route many new investors should be going down.
The risks are higher, the stress levels will be higher if you’ve not invested in two or three properties before, and it could spoil your whole experience of investing for a long time if you get it wrong.
But if you’re experienced and you’re aware of the pros and cons, bridging finance could be a great tool to use.
For more hints and tips, go take a look at the education section and the free courses we’ve got over at Property Hub University.