In the first article of this bridging loan series we discussed 5 reasons why you should use bridging loan finance. In this article we will now discuss how to structure a deal.
Structure the deal
Let’s start with the fee’s, in most cases any fees associated with the deal can usually be deducted from the total loan amount. This is normally completed before the funds are paid over to you.
For example if you decided to borrow lets say £80,000 with an arrangement fee of 2% and legal fees of £600 you would receive a total of £77,800.
Before agreeing to the terms you need to make sure you read the small print and establish if there will be an exit fee. Not all lenders charge an exit fee, however some do. The main reason for knowing this information is due to the fact that it is charged at the end of the loan term not at the begging. So if you have not budgeted for it, it can come as a bit of a shock.
Now all that’s been discussed there is just one more thing to think about, the interest!
3 Main Types of Interest
With a bridging loan there are three main ways in which you can pay the interest on the bridging loan.
- Rolled up
So let’s take a closer look at the three types of interest.
You can have the interest withheld, this means its deducted from the gross advance as well as the fees at the beginning. This a great option if you have a good LTV.
For example let’s say you have a property to the value of £100,000 and you need £50,000 in the bank. Just imagine the interest was £10,000 and the fees £2,000. You could ask for a total loan of £62,000 and you would then end up with £50,000 in the bank.
Yet just be careful as this deal would not work if you wanted £70,000 in the bank. One thing to beware of is that most lenders will only lend 70% LTV. So if you can now see that if you borrowed £70,000 after deducting interest and fees you would end up with much less.
The next option is rolled up, this means you will not pay the interest until the end. However, when you do pay it will be in one lump sum.
This is suited to borrowers who are unable to make monthly interest payments. In these circumstances, interest is typically compounded. So, while a borrower will not pay interest monthly, the repayment at the end of the term will be much larger as your loan is increasing month on month which in turn increases your interest payments.
For example, lets imagine the repayments on a 12-month bridging loan to the value of £100,000 with monthly interest at 0.75%
Normally it would be £750.00 per month.
However, if you choose not to pay this and decide to roll it up this is what happens.
You can start to see in just 5 months how this can quickly start to add up.
Using this example, the compounded interest payable would be £109,380.09 compared to £109,000 if you had not allowed it to roll up.
The last one is servicing, this means you can choose the option to make a monthly interest payment. One thing to note is that if you do decide the service the debt monthly, most lenders will allow you to take the bridging loan over a longer term.
Servicing the interest monthly will not reduce the amount you receive at the beginning.
if you are thinking about bridging you need to first of all consider your own individual circumstances as this will in most cases dictate the option you choose.
So when would be the best time to use bridging finance?
- Property Flips – For example you want to buy a house quickly for a reduced price and sell it on.
- Property Refurb – Purchase a run down property that in its current state would be unmortgageable.
- Auction Purchase – Needs funds quick.
- Any situation where traditional lenders are not interested.
Bridging Loan Summary
There are some very clear advantages for using short term bridging finance which include:
Bridging loans in some cases can be arranged in a matter of hours.
Lenders allow you to roll up interest payments until the end when the whole loan is paid back in full.
Loans can be more flexible, with many offering no early repayment penalties.
However, like with many financial products there are some very obvious disadvantages which include:
High interest rates.You would typically pay 1-1.5% a month in interest for an open bridge.
Fees are expensive. You will normally must pay a fee of around 1 – 2% which will be taken out of the loan. There may be broker fees on top as well as valuation and legal fees.
The bridging loan market even with its high costs has steadily grown in the last 5 years. This is due to the fact that property deals need to be snapped up quickly. Buyers who are looking to grab a bargain understand that many of the properie would not attract the more traditional routes.
There is still a gap for another alternative provider in the market, however the likes of crowdfunding and in some instances investors do not cut the mustard.
So until then bridging will remain a popular option.
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