Short term finance solutions: when are bridging loans viable in property investment?
Problems with cash flow can quickly become the bane of many property businesses. At some point, you might well find yourself needing to make a payment fast, but are without access to funding until later on in the month. Situations like these can often stress out even the most seasoned of professionals, and it can be a struggle to find an option that can secure your investment fast enough. In recent years, however, a particular solution to this problem has gained increasing popularity: bridging loans. Here, we’ll take a closer look at what bridging loans are, what options are available, and how they can be utilised to help you solve any potential short-term financing problems you might experience.
What are bridging loans, and when might you need them?
As the name suggests, bridging loans are a type of loan that allows you to borrow money quickly for a brief period of time. They’re able to help you get through a stretch of cash shortage by providing you with immediate financing when you most need it, whether this is to complete a property purchase, renovation, or finalise an investment.
Imagine you’re bidding for a property going under the hammer, but there’s an issue with your finances, so you won’t be able to pay the 10% deposit within the time frame required, even though you know you’ll have the full funding for the property by the final deadline. Here, a bridging loan can help you to cover the deposit fast enough that you can secure the property, and get on with business.
How much can you borrow?
As is typical of most financial options, the amount you can borrow will vary from lender to lender. Though commonly, the minimum amount can be as little as £10,000, whilst the maximum might be up to 70-80% of an asset’s value, depending on your individual circumstances and the security that you provide. Usually, this type of loan will be secured against residential property, commercial property, or a plot of land, and repayment will usually take place within 12 months.
The interest gained on the loan can be repaid monthly, or ‘rolled-up’ — essentially, added to your balance as it becomes due. If you choose the roll-up option, the amount of interest you have to pay is calculated every month on the outstanding balance. For instance, if you borrow £100,000 at a monthly rate of 1%, during the first month you’ll accrue interest for £1,000, and your balance will become £101,000 (plus any administrative fees and charges).
Often, interest can be ‘retained’, which means that lenders set aside a portion of your loan to cover a certain amount of interest payments. In practice, though, you’re borrowing both the funds you need, and extra cash to cover the interest. So, if you require funding for £100,000 and want to retain interest to the tune of 1% per month for 12 months, the gross loan you’ll have to get is about £113,000, plus any administrative fees and charges.
What options are available?
Bridging loans generally fall into two categories: closed and open. Closed loans specify a pre-agreed repayment date, and is often ideal to tide you over when you know cash is imminent, such as the time between the exchange of contracts and completion date on a property sale. They also generally offer lower interest rates than their counterpart. Open loans, on the other hand, have no pre-set repayment date, although they usually set out your strategy to settle the debt, and the maximum cut-off point after which the loan must be repaid.
Are bridging loans a good idea?
There are a number of general misunderstandings about the nature of bridging loans, and they tend to centre around costs. This is because the costs incurred by bridging loans are often larger than, say, a standard mortgage. It’s certainly true that a short-term loan, being riskier for the lender, can be more expensive — the lender’s arrangement fee, for instance, is in the region of 1% to 2%, and interest often works out at about 1% per month (although this crucially varies, depending on the lender, the security you provide, and the ratio between loan and asset value, as well as, of course, the Bank of England’s base rate). Yet, the fundamental principle here is that bridging loans are a short-term arrangement so comparisons with other forms of funding are reminiscent of the proverbial apples and pears.
If you keep your bridging loan to the brief timespan it was devised for, this keeps costs in check — provided, of course, that you choose a product you can afford and have a clear, realistic exit route from it, such as getting a mortgage or completing a property sale. You should also pick the interest option that works best for you, and have a backup solution in case your primary exit plan doesn’t work. As is the case with most financing tools, you run the risk of losing your security asset if you don’t repay your debt. If you do all this, though, bridging loans can potentially become a very useful tool in your arsenal.
Flexibility is key
Ultimately, a bridging loan’s biggest advantage is that it gives you fast access to money. Unlike longer-term financing, it can be arranged in as little as a week, and usually between two and four weeks, depending on the amount you request and the security you provide. So if an investment opportunity presents itself and you need to act quickly, a bridging loan can make the difference between closing the deal and missing out.
It’s also more flexible than many other financial products and can usually be repaid as soon as you come into your long-term funds, with only a few bridging loans coming with early repayment charges. This makes it very useful if you need to buy and refurbish a property before reselling it. The loan gives you the funds you need to carry out the work, and you can pay it back once the sale is completed.
Because lenders are mostly concerned about the security you can provide, rather than your source of income, self-employed property professionals may also find it easier to obtain a bridging loan than a mortgage. And of course, these loans are particularly handy in circumstances when it may be very difficult or impossible to get a mortgage, such as, for example, if you are rebuilding a property in very poor condition.
The bottom line
If you’re in need of speedy capital, then bridging loans might prove a suitable solution for you. Whether you’re trying to finalise your investment or finish off your renovation, their simplicity, ease of access, and speed make them a useful tool for any investor. It’s always important though to weight up all of your options, and to find the best solution to suit your individual needs. This can be a difficult process, however, and can often require advice from other professionals within the industry.
At Qandor, we offer a friendly, driven environment for property professionals to share knowledge and collaborate. If you’re interested in discovering more property investment insights, just head over to our Advice page for more information.