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

What is a Bridging Loan?

Picture the scene. You’ve found your dream home, you’ve put in an offer, and the current owners have accepted. However, your house is yet to be sold, and your plans for your new home might fall through at any moment if the sellers receive a better offer. You have to move as quickly as possible to make sure you stay in the game. What can you do?

A common response is to use what’s known as a bridging loan. While it might help you keep hold the property you want, it’s important to note that they’re usually expensive, and can leave you in a bit of a financial mess should the whole thing fall through; even if they work, you’re left paying off a loan (usually at a high interest rate) in addition to a mortgage on your new house until your old house sells. As a result, they should be considered a last resort, and not just a way of quickly getting out of general property-chain problems.

Generally speaking, there are two different sorts of bridging loan: ‘closed’ loans, and ‘open’ loans. To be eligible for a closed bridge loan, you must have already agreed to an exchange on the sale of your current house. It’s very rare for sales to collapse after an exchange, so financial institutions feel pretty comfortable about offering closed loans in this situation. However, open bridges are necessary for those customers who are looking to buy a specific property, but might not yet have put their current home up for sale. To get an open loan, you’ll need to have a lot of equity built up, and be willing to answer a whole host of questions from your bank.

One major advantage of a bridging loan is that they don’t generally include penalties for early repayment, while some mortgages do. As such, you can pay off the remainder of your loan the second the sale of your house goes through, without incurring any additional fees. However, as they’re only designed to be a very short term solution to the problem (with most banks limiting the loan length to 12 months before calling it in for renegotiation of terms), the interest rates attached to these loans are often quite high – usually between 2 and 2.5% above the Bank of England’s base rate. You can expect an arrangement fee to be applied as well (often about 0.75% of the loan). This can be off-putting for some buyers, but doesn’t necessarily have to cost you a great deal extra, especially if you can get the sale on its way as soon as possible.

Bridging loans aren’t for everyone – some people may find that remortgaging their property and renting it out until the deal can go through is a better option, especially if they suspect that it may be some time before they’re able to sell their current property – but it can be a useful tool in the short-term, especially if you find yourself at the mercy of a small hiccup in the house-selling process that will be relatively easy to resolve, or at times when the housing market has fallen a little slack.