Bridging Loans are Expensive!
Let’s start with a fact that if you are looking for a cheap funding solution for your next property deal then bridging may not be for you. Bridging loans are expensive!!
It’s important that you match the right finance product with your funding need.
In this two part article we are going to discuss everything you need to know about bridging loans. Make sure you read the both articles before making your final decision.
First of all one thing to point out if you do decide to use a bridging vehicle and you use it correctly. Bridging loans can be a very powerful tool to have as part of your property development strategy.
Why I here you ask!
Well you can use bridging loans to acquire property that normal other finance options would not fund.
5 Reasons When People Use Bridging Loans
- When a traditional mortgage lenders say no
- You may have a low income
- The property needs refurbishment, so there is no rental income
- The property has no kitchen or bathroom which a main criterion for traditional lenders.
- You need the money quick in a few days. Not months as indicated by most lenders
Now under these circumstances bridging loans can provide you with a perfect solution.
In most case bridging lenders are not interested in:
- Personal income
- Rental income from the property.
- The condition of the property for example no kitchen, bathroom or structural damage.
One other great thing about bridging loans they are very very quick! In most cases you can have your funds in days rather than months..
You can now start to see their appeal
There are two types of bridging loans
- A ‘closed’ bridging loans:this is a bridging loan where there’s a guaranteed exit in place, because long term funding has already been arranged. However, because property sales and mortgages can fall through at the last minute these are far less common.
- An ‘open’ bridging loans:this loan is used where there isn’t a definite exit date for the lender because long term finance isn’t in place. It normally runs for a specific period, such as six or nine months, but it can be longer.
How do they work?
Lets use this recent customer as a case study.
A luxury Leeds property purchased by the client with a view to refurbishing it to a very high standard before leasing it out.
The client had a poor credit history, the client came to us when it emerged that other lenders would not provide him with financing.
► Loan amount: £1,350,000
► Independent valuation amount: £2,350,000
► Term: 12 months
The loan was completed within 11 working days. The client then finished the refurbishment and subsequently let the property. Thus providing him with multiple buy-to-let refinancing options.
Interest rebate on early repayment
Yes (subject to 3 months’ minimum interest)
Using the case study, we can now look in detail at all the areas. We will start off with valuation.
The valuation is completed by an independent third party, usually they will be a registered RICS surveyor. Their role is purely to inspect the property and determine its value.
Over the years I have seen many property developers be disappointed. When they have later received their valuation. These surveyors will air on the side of caution when giving out valuations. The main reason is so that there will be no come back on them should anything go wrong later. So, try to work off conservative numbers if you want to ensure your project is a success.
Now many lenders will ask you to give information to support any valuation that you have put down on the initial application. However in most cases they will still want an independent valuation as well. Or in some cases they will ask for the valuation to be addressed to them… This is just in case the lender wants to take legal action against the valuers later for inaccurate valuation. So be prepared as you may need to pay for this but its cheaper than a new one.
Now you understand why valuation is so important as the whole deal will be based around the result.
The valuation is often referred to in the industry as the LTV loan to value
With a traditional mortgage it’s the size of the loan divided by the price of the property.
The property value is £100,00 and the loan is £75,000, the LTV will be 75%
For mortgages the value of the property will always be the lower so for example you find a property that’s worth £100,000 on the open market but you make a cheeky offer and get it for £85,000.
The lender will then value it at £85,000.
If they are then prepared to give you a LTV of 70% this means you will receive an offer for £59,500 which is 70% of £85,000 rather than what you wanted which would have been £70,000 or 70% of £100,000.
Bridging loans are different
This is where bridging loans slightly different and why so many people use the facility. Some bridging lenders will lend on the properties current market value and ignore what you paid for it.
So, based on the previous example you would be able to borrow based on the property value of £100,000.
Taking it one step further some lenders will offer loans based on the gross development value. This means what the property will be worth once the works have been completed.
A quick summary of how that looks in financial terms
70% purchase price
70% market value
That’s sounds great but what’s this going to cost?
If you have already had time to look around you will already understand when I say its difficult to compare bridging loans. The reason is every lender is different and fees vary tremendously.
Let’s start off with the fees
Interest rates are only one component of the costs associated with bridging loans.
So prepare yourself as you might have to also pay:
- Initial valuation fee
- Arrangement fee or facility fee.In the first case study this was 2% of the loan.
- The lender’s legal fees plus your own
- An exit fee which might be around 1%, however not everyone has an exit fee.
- If you are using a broker, they could charge 1% of the loan.
Wow! I did say they were expensive!
Do not be fooled by tempting low rate headlines, often these lenders will be the pickiest when it comes to deciding who to lend to. So, if you lack years of experience and want to borrow more than 50% LTV you may be disappointed when then they turn your application down.
You can check out some of the latest rates by visiting my bridging deals of the day page.
Remember cheap headline rate does not mean the over deal is the cheapest.
To highlight this point just last week two sets of terms for the borrower both had a 2% arrangement fee and a monthly interest rate of 0.60% per month. Yet one lender had a £650 plus VAT upfront valuation fee and the other was charging £1870 plus VAT for the same service.
If you decide to bridge your next property development the lender will want to take a first or second charge. If you can give a first charge you will benefit from a lower rate.
So, what is a charge?
The lender will take the charge over the property to secure the loan. This charge is noted on the land register which means you will not be able to sell the property or raise funds against it without the lenders approval.
On the other side of the coin it also means the lender can and will force the sale of the property to get their money back if you don’t repay.
Most lenders like to take a first charge which means the loan is just from one lender. However, it is also possible to get a second charge loan on the property of you already have one.
A second charge can be useful if you already have a longstanding mortgage against a property for 30% of its value but want to keep it because of its low interest rate. Yet you want to raise additional funds.
In the second part of this article we will discuss deal structuring and interest payment methods.