What is a bridge loan?

Bridging or bridge loans ‘bridge’ the gap when you need to pay for something but you’re waiting for funds to become available. They’re often used by people who are taking out a mortgage to buy a property but are waiting for the sale of another property to go through and you might consider a bridging loan to cover the period between purchasing your new home and selling your old home. It allows you to borrow the money required for a short time like purchasing a property before you’ve sold your existing one, to fund renovations or a new build project before securing a traditional mortgage, buying a property at auction, where you’ll need the money immediately but may not have sold your current property yet. Bridging loans are secured loans like mortgages which means you have to have a high value asset to get one, such as a property or land.

How does a bridging loan work?                                                                                                                    There are two types of bridge loans: 

 1) Closed bridging loans: 

With a closed loan, there is a fixed repayment date where you will normally be given this kind of loan if you have exchanged contracts but are waiting for your property sale to complete and you have given a fixed end date, this date is usually based on when you know you’ll have funds available to pay back, sometimes called mortgage bridging loan. Typically you only need to borrow the money for a short time and they’re usually short term bridging loans lasting just a few weeks or months. 

 2) Open bridging loans:   

With an open loan, there is no fixed repayment date, but you will normally be expected to pay it off within one year  and sometimes even longer. These have no set end date. This means they can be repaid whenever your funds become available.  Whichever kind of loan you take out, the lender will want to see evidence of a clear repayment strategy, such as using equity from a property sale or taking out a mortgage. They will also want to see evidence of the new property you are purchasing and the price you plan to pay for it, as well as proof of what you are doing to sell your current property if relevant. Open bridging loans are usually more expensive than closed bridging loans because they’re more flexible.

Key Points:

• First charge and second charge: When you take out a bridging loan, a ‘charge’ is placed on your property, you’ll be told it’s either a ‘first charge’ or ‘second charge’ loan. This is a legal agreement that prioritises which lenders will be repaid first should you fail to repay your loans, If you have an existing mortgage, the bridge loan becomes a second charge which means if you failed to meet repayments and your home was sold to pay off your debts, your mortgage would be paid off first. It could also be used to pay off your original mortgage. In this case the mortgage is settled, so your bridging loan is registered as a first charge loan.
• Fixed and variable rates: As with most loans, the interest rates on bridge loans can be fixed or variable. With a fixed rate you’ll know exactly how much you’ll be charged, your monthly repayments will be the same and interest rate won’t change throughout the term of the loan. With a variable rate, the interest rate can change and its usually set by the lender. Lenders might follow the Bank of England’s (BoE) base rate which means your payments can go up and down. Your bridging loan should only be in place for a short time, so you might not be affected by a changing interest rate Fixed rates are likely to be slightly more expensive. 
• How much can you borrow depends on key things like, your credit rating and the value of the property. It can vary greatly ranging from £50,000 to £25 million or even more. If you are taking out a first-charge loan, you’ll typically be able to borrow more than if you were taking out a second charge loan but you’ll usually only be able to borrow a maximum loan-to-value ratio (LTV) of 75% of the value of your property.
• Bridge loan rates tend to be pretty high and are often calculated on a monthly basis, rather than an annual basis which makes it an expensive way to borrow money and its one of the major downsides of a bridging loan. You could charged a fee between 0.5%-1.5% per month which is the equivalent to an Annual Percentage rate (APR) between 6.1% and 19.6%. Lender might give you an option for Deferred or rolled up interest rate which basically means, you pay all the interest at the end of your bridge loan and there are no monthly interest payments. Other option available is Retained which is, you borrow the interest for an agreed period and pay it all back at the end of the bridge loan. There may also be a set up fees which you need to consider.