A guide to bridging loans

A bridging loan is a short-term loan that can be used to cover a gap between financial transactions, such as when money is going out but not yet coming in.

In this article, our expert team of financial advisers at PIL Southampton covers everything you need to know about how bridging loans work.

What is a bridging loan?

A bridging loan is a short-term loan that is taken out at short notice. You may require funds to purchase a property, but the funds required are not available soon enough. A bridging loan fills this gap. The term ‘bridging loan’ refers to this ‘bridging the gap’ scenario.

They tend to be much faster to arrange than a mortgage.

Types of bridging loan

There are two types of bridging loan – open and closed.

An open bridging loan has no official fixed repayment date and can technically be paid whenever you have the funds available to pay it. However, most lenders will expect you to pay them back within one year. There are some lenders who do offer a longer repayment period than that.

Conversely, when you take out a closed bridging loan you are committing to repay the money on a fixed repayment date. This date will usually be based on the expected completion date for your property sale.

Because there is less repayment flexibility with a closed bridging loan, the interest rate will generally be lower than the interest rate for an open bridging loan.

Whichever bridging loan you take out, your lender will need to see evidence of the plans you have in place to repay your bridging loan on time. This detail is sometimes referred to as an ‘exit plan’.

What are ‘first charge’ and ‘second charge’ bridging loans?

As security for your bridging loan, your lender will place a ‘charge’ on your property, which gives them the right to repossess your property and sell it, in order to recover the money they lent to you if you fail to keep up your repayments.

A ‘first charge’ bridging loan applies when you have no other loans outstanding on that property, i.e. you own it outright. So, if you default on your payments and your home is sold off, your bridging loan lender will be the first party to be repaid.

If you do have loans secured on the property, such as a mortgage, and you default, the mortgage lender will be first in line to be repaid, and the bridging loan lender is paid after, hence being the ‘second charge’.

The interest rates are usually higher for a second charge bridging loan than a first charge bridging loan. This is because there is a higher risk that the funds won’t be available to be repaid when the property is sold, after the mortgage lender has recouped their sum owed.

Note: A second charge bridging loan will need to be approved by the first charge lender – this is usually your mortgage provider.

What can I use a bridging loan for?

Most commonly, property investors, landlords and homeowners use bridging loans to enable them to buy a new property before funds have been released by the expected sale of another property. 

How much can I borrow with a bridging loan?

A lender could be prepared to offer anything from £5,000 to tens of millions of pounds, depending on your credit history and your financial circumstances.

However, a general rule of thumb is 75% of the value of your property. Again, due to the higher risk involved with a second charge, you are likely to be able to borrow more money for a first charge bridging loan than for a second charge bridging loan.

How do you repay a bridging loan?

One way is to make interest payments every month, throughout the term of your bridging loan. 

Alternatively, you can pay the accumulated interest when you repay your bridging loan in full at the end of the loan term. This is often a preferred option for anyone who is already incurring monthly payments for a mortgage and can’t, or doesn’t want to, find the funds to pay another monthly expense.

How much does a bridging loan cost?

Due to their short-term nature, interest rates for bridging loans tend to be a lot higher than a mortgage and other types of loans. Because they are usually paid back in only a few months, it is the norm for interest to be charged monthly rather than by an APR – annual percentage rate. 

Small changes in monthly interest rates make a big difference when calculated as APRs. For example, if you take compound interest into account, a 1% monthly rate would equate to 12.7% APR, whereas a 2% monthly interest rate is equivalent to a 26.8% APR.

Lenders who don’t charge interest on a monthly basis might defer – or roll up – the interest due, meaning that you pay all the interest at the end of your bridging loan.

Other costs likely to be incurred when you take out a bridging loan include legal and valuation fees, arrangement fees and admin/repayment fees. You should be able to add all these fees to the lump sum of your loan but note you will pay interest on the fees as well as the loan.

You may also need to pay exit fees if you choose to repay your loan early. 

Can I get a bridging loan if I have bad credit?

Although some lenders will potentially lend to you if you have a poor credit rating, the interest rate will inevitably be higher as you will be deemed to be higher risk.

As is the case before you apply for any loan, it can be beneficial to do everything you can in the months before you apply, to make sure your credit rating is as good as possible.

Measures you can take to improve it include:

• Make sure you’re on the electoral register.
• Avoid moving home if you can.
• Wait as long as you can after having a late or missed payment.
• Keep an eye on your credit score and ask the credit reference agency to correct any discrepancies.
• Pay all your bills on time and avoid taking out payday loans, large credit agreements or defaulting/being late on payments on credit cards and car loans.
• Try to avoid using your overdraft and keep below 25% of the available limit on your credit cards.
• Sever outdated ties with other people, i.e. an ex-partner, to avoid being associated with them if they have a poor credit rating.

What should I consider before taking out a bridging loan?

With the majority of bridging loan terms being a maximum of 12 months, think about whether you are realistically going to have the money ready to pay back your bridging loan in time – will your house sale go through by then? And, if time is running out and you have to reduce your price to get a quick sale, will the proceeds still cover your bridging loan repayment? 

Don’t forget, if you can’t repay it on time, you may need to pay additional fees and charges, and your home could be at risk of repossession. 

Are there any alternatives to a bridging loan?

Although the specific purpose of a bridging loan is to meet the need for a short-term loan, there are other options.

Personal loan

A personal loan could be an option if you require a relatively small bridging loan and can generally be processed as quickly as a bridging loan. This could be as much as £50,000, although £25,000 is a more usual upper limit. Your home isn’t at risk as personal loans aren’t secured against the property, and repayments tend to be lower as interest rates are calculated as APRs. Taking out a long-term loan would mean lower repayments. 

Secured loan

A secured loan gives you the opportunity to borrow a larger amount than a personal loan. Charges and interest rates are usually lower than a bridging loan. However, just like with a bridging loan, your home is at risk if you don’t maintain your repayments.

Re-mortgaging

Alternatively, you could consider remortgaging your current home to release some capital, although this process is likely to be longer than an application for a bridging loan, which may not suit your timeframe.

How do I find the best bridging loan for me?

Bridging loans can be a costly way to borrow money, so be clear on how much you need and how long for – the shorter the timeframe the less it will cost you.

When you approach lenders, you’ll need to provide information including how much the property is worth, whether you have a mortgage and what the outstanding balance is, how much equity you have in the property and what your monthly income and expenditure is.

Everyone’s circumstances are unique and there are a lot of choices out there. It can be mind boggling and time consuming to trawl the marketplace and try and work out the best option for you. This is where turning to a professional, independent financial adviser can save you a lot of time and give you the peace of mind of knowing that the best options for you are being brought to your attention.

How PIL Southampton can help you 

Our friendly team of independent financial advisers is very experienced in this area; they regularly help to arrange bridging loans for their clients.

They are always up to speed on the variety of products available across the marketplace, and will use this knowledge, and everything they have taken the time to find out about your financial circumstances and needs, to make sure they give you the most appropriate advice on your options. 

How you can contact PIL Southampton

You can email us, fill out the contact form on our website or call us on 02380 668407. We look forward to hearing from you.