Bridging that finance gap

Bridging finance is a short term loan for a property buyer who can’t complete because of a problem in the chain behind him.

A bridging loan allows the buyer to proceed with the purchase while the other problems sort themselves out behind them.

The downside to bridging is the buyer is often left with two loans – a mortgage on the property they are selling and the new bridging loan on the property they are buying.

Banks and specialist lenders provide bridging loans. The deal is generally based on the property offered as security but the interest rates will be higher than an ordinary mortgage and the loan-to-value lower – perhaps only 70% of the value of the property.

The key to borrowing on a bridge is the ‘exit strategy’, which is how you will pay off the loan.

Most borrowers exit strategy is to replace the bridging loan with a mortgage as soon as they can.

The problem is you have to be absolutely certain you will complete the sale of your former home and have a mortgage in place on your new home before contemplating a bridge. If you are not in absolute control of both ends of the deal and cannot guarantee an exit strategy, you should not consider a bridging loan as the lender my take possession of the property if your plans fall through.

Bridging loans come in two types:

• Closed bridging is for a time limited period like a week, a month or three months – useful if the completion date for your old property is set.

• Open bridging has no time limit and often attracts a higher rate of interest.

Expect to pay fees as a percentage of the sum borrowed. You will also have to budget for paying both your own and the lender’s solicitors, a valuation and possibly a broker fee as well.

A typical bridging loan is at least 1% above bank base rate and can be much higher depending on the lender and how they view the risk.

An alternative to a bridging loan is a ‘let and buy’ mortgage. With this product, you keep your existing mortgage on your old home but tell the lender you are converting to a buy-to-let product, which may cost you a little more in interest repayments.

You let the property to a tenant and the rent you receive pays the mortgage. Meanwhile, another lender gives you a mortgage on your new home based on normal lending criteria.

A ‘let and buy’ mortgage may be advantageous because you can sell your former home at your own pace and this gives you a capital gains tax advantage because the last 36 months of ownership of a property that has been your main home is exempt from CGT when you sell.

That means providing you lived in your former home for all the time you owned it less 36 months, you pay no CGT when you sell. You can also afford to sit out any drops in the market and wait for a better price.

You also have a capital gains tax exemption on your new home at the same time.

Bridging loans are expensive, last resort borrowing and you should take financial advice and consider carefully before entering in to an agreement.

Summary

• A bridging loan is short term finance available from banks and specialist lenders

• The interest rates and fees are generally higher than other borrowing because the lender knows you have nowhere else to go

• Consider a ‘let and buy’ mortgage as an alternative as the rates are cheaper and the you pick up capital gains tax advantages