Bridging finance: the ultimate guide

The most important and obvious similarities are:

• The amount the lender will give you is determined by the value of the property
• They’ll take a “charge” over the property as security – meaning they can repossess it if you default on the loan
• You’ll pay interest for the agreed loan term, then pay the loan back at the end

So far, so similar. But there are important differences too…

How does bridging differ from a mortgage?

The most important difference is the duration: you’ll often take a mortgage out for 25 years or more, but bridging is generally for 12 months or less.

The other noticeable difference (and not in a good way) is the cost. Mortgage rates at the moment are under 5% per year for most borrowers, but bridging tends to be 8% at the very lowest end – all the way up to 15% or more.

Those are the most obvious differences when you sit down and compare the two. But there are other differences too – and it’s these that allow you to use bridging in creative and interesting ways:

• In general, bridging lenders aren’t bothered about your personal income – so you can get a bridging loan even with low earnings
• Bridging lenders aren’t bothered about the rental income the property could produce (because it wouldn’t be unusual for the property to be empty for the whole term of the loan)
• The condition of the property doesn’t matter so much. No kitchen, no bathroom, no way to keep the rain off because the roof is full of holes? No problem
• And importantly, bridging finance can be much quicker to arrange: think weeks (in a pinch, days) rather than months

First and second charge lending

As we’ll see in more detail later, lenders take a “charge” over the property to secure their loan. This charge is noted on the Land Registry, and means that you can’t sell the property or raise money against it without the approval of the lender – and also means that the lender can force the sale of the property to get their money back if you don’t repay.

Most lending is on a “first charge” basis – meaning that you take out a loan from just one lender, and they’re first in line to claim the proceeds when the property is sold. But it’s also possible to get a “second charge” loan: if you have a loan already you can take out an additional loan, and the second lender sits behind the first in order of priority.

This doesn’t mean that you could have two lenders each lending you 70% of the property’s value. Clearly, both need to get paid back from the sale of the property if anything goes wrong – so the two loans combined can only add up to somewhere in the region of 70% in total.

A second charge loan can be useful if – for example – you have a longstanding mortgage against a property for 30% of its value which you want to keep because it has a low interest rate, but you also want to raise additional funds. There are two things to bear in mind though:

1. The first charge lender will need to consent to a second charge lender coming in behind them. Some won’t allow it, because it’s a potential source of complication and hassle that doesn’t really benefit them in any way.
2. Second charge lending is more risky for the lender, because if they need to force sale of the property they’re only second in line for the proceeds. As a results, interest rates tend to be higher.

The first is in situation where you don’t want to hold the property for very long – or you want to remortgage quickly to realise an increase in value.

For example, say you want to flip a property. You shouldn’t use a mortgage, because a mortgage is intended to be held for a number of years – so cash or bridging are your only options.

Alternatively, you might want to refurbish a house to increase its value then borrow against its higher value. In that situation, bridging is appropriate too: use bridging to increase the value, then take out a mortgage based on its new value.

The second is a situation where speed matters. Because you can arrange bridging in weeks rather than months, it allows you to compete with cash buyers in situations where you can get a good deal by moving quickly. Auctions are one example, but also any case where the seller is willing to sell at a discount if you can complete quicker than a mortgage would allow you to.

The third is where the property isn’t mortgageable. From a mortgage lender’s point of view the property doesn’t need to be a palace, but it needs to be habitable (and therefore rentable) before they’ll lend against it.

That’s a problem if you want to buy a wreck of a property at a good price then bring it back up to scratch. You can’t get a mortgage against the property when it’s a wreck – but you could use bridging instead (as lenders are less fussy), then take out a mortgage to repay the bridging loan once you’ve finished the refurbishment.

Of course, these situations overlap too. Often properties that are in disrepair and are unmortgageable are being sold quickly (sometimes at auction). Often too, you might not want to hold this property for very long – just enough time to refurbish then sell on again for a profit.

There are plenty of other cases where bridging comes in useful – some of them more advanced – but these are the majority of situations you’ll come across.

Understanding loan-to-value

From your experience with mortgages (even if just on your own home), you’ll already know what loan-to-value is: the size of the loan divided by the price of the property. So a loan of £75,000 against a £100,000 property will have an LTV of 75%.

But what determines the “value” part in the case of bridging?

For mortgages, the “value” of a property will always be the lower of its current value or the purchase price. In other words, if a property would be worth £100,000 on the open market but you’ve snaffled it for £85,000, the lender will value it at £85,000. If they’re prepared to give you an LTV of 70%, that means you can borrow £59,500 (70% of £85,000) rather than the £70,000 (70% of £100,000) you might have wanted.

In the case of bridging, it’s often no different. But some bridging lenders will lend based on just the current market value – and ignore what you paid for it. So in our example above, you would be able to borrow based on the true £100,000 value – and therefore borrow more money, assuming the same LTV.

Some lenders will also offer loans based on the Gross Development Value (GDV) – which means what the property will be worth once you’ve completed your planned works on it.

Continuing the same example, say that once you’ve given the property a comprehensive refurb it will be worth £120,000. A lender might then give you (say) 70% of this figure – which is £84,000. Initially they’ll only give you an amount based on its current value, but they’ll give you the extra at the end once you’ve done the work to increase the value – or give it to you in stages as work progresses.

If you can find a lender who’ll lend based on market value and also contribute to the cost of the works (by lending against GDV), you’ll be able to borrow more money than you otherwise would. This is obvious to see when you consider the exact same situation assessed by three lenders with different criteria:

If you’re trying to stretch your cash as far as possible so you can afford to do a project, that’s a big difference. But remember: borrowing more means higher interest charges, which you’ll need to factor into the cost of completing the project.

The importance of the valuation

Just like with a mortgage, the bridging lender will instruct a RICS-qualified surveyor to inspect the property and determine its value. And just like with a mortgage valuation, you might be disappointed by the figure they decide on.

You’re almost guaranteed to disagree with their valuation, because you’ll be looking at the project optimistically and they’ll be playing it safe so they can’t get into trouble with the lender later. It’s just one of those things: to reduce the risk of a valuation scuppering your plans, try to work off conservative numbers so you’ll still be able to get the loan you want even if the valuer doesn’t share your optimism.

If you already have your own valuation, it will almost never be sufficient: the lender will want to instruct their own valuation, which you’ll need to pay for. In some circumstances, if you have a recent valuation a lender might agree to that valuation being updated so it’s addressed to them: this means that the lender can take legal action against the valuer if they later lose money as the result of an inaccurate valuation. The valuer will sometimes charge to re-address a valuation (which you’ll have to pay for), but it’ll be much cheaper than getting a whole new one.

What else will lenders want to know?

The valuation is the main factor that determines how much you can borrow. Unlike with a mortgage, the lender doesn’t need to probe endlessly into your situation, your ability to afford repayments, the rent the property would achieve, and so on. It’s this simplicity that gives bridging its speed and power.

But depending on the lender, there are other factors related to you, not the property, that they might want to get to the bottom of before agreeing the loan:

• What experience do you have at executing this type of project? This will be particularly important in the case of HMOs or development projects that go beyond a simple refurb
• How will you pay the loan back? If you plan to remortgage, how likely will you be able to do so – given the type of property and your personal circumstances? If you plan to sell, will the property be marketable?
• Will you be able to achieve your exit before the term of the loan runs out?
• What other assets do you have? These are assets the lender would be able to go after if you default and selling the property isn’t enough to clear the debt
• What income do you have? This is mostly relevant if you plan to make interest payments monthly, rather than at the start or end

The emphasis that lenders put on these “non-property factors” will depend on their attitude to risk and the type of lending they like to do. Some lenders really aren’t too fussed – knowing that if you default they can force sale of the property to get paid back anyway, and probably charge huge penalty fees so they end up making more money than they would have done if you’d paid them back on time. Others are far more minded to turn down projects they don’t believe will succeed, because they don’t relish having loans default and having to go through the repossession process.

The fees you’ll need to pay

The interest rate is just one component of the cost of bridging: loans also come with fees, which can be the most painful part of the experience.

It’s hard to generalise about the level of fees because they vary wildly between lenders. To give a ballpark estimate though, you might find yourself needing to pay:

• For the initial valuation
• An arrangement fee or facility fee, which might be around 2% of the loan
• The lender’s legal fees, as well as your own
• An exit fee, which might be about 1% of the loan
• A whole array of other fees, depending on the lender
• And if you took out the loan through a broker, the broker fee will often be 1% of the loan

So as well as the interest, you can find yourself paying 3% of the total loan in fees plus two sets of legal fees. Yup, bridging finance isn’t cheap: but if it allows you to do profitable deal that wouldn’t otherwise have been possible, it’s worth it.

Lender fees are all over the place. Each lender will charge different fees, call them different things, and structure loans in different ways – which is why a broker can be useful to help you find the most suitable deal. Although the broker, of course, will charge a fee of their own.

The lenders with the lowest fees tend – as you might expect – to be the most picky about what they’ll lend on. So if you’re very experienced and you want to borrow under 50% of the property’s value for a straightforward project – and you’re not in a rush – you can probably find a lender with very competitive fees. On the other hand if it’s your first project and you want to borrow as much as you can quickly, you’ll have to expect to pay more.

Structuring the loan

The fees associated with the loan will usually be deducted from the gross advance before it’s paid over to you.

For example, if you agree to borrow £70,000 with an arrangement fee of £1,400 and legal fees of £600, you’ll end up with £68,000 actually landing in your bank account as the net advance. The exception is exit fees, which (as the name implies) are usually added at the end rather than deducted at the start.

As well as the fees, there’s the interest to think about. There are three ways to pay the interest on a bridging loan:

• The lender can withhold the interest, meaning it’s deducted from the gross advance (along with the fees) at the start
• You can roll up the interest, meaning you pay it in one lump sum at the end
• You can service the interest, meaning you make an interest payment every month (just like with a mortgage)

The lender may give you a choice of which method you prefer, or might insist on a certain method being used. Each method has its own pros and cons:

Withholding the interest is a good option if you’ve got plenty of LTV headroom, because it keeps your total interest cost down and saves you from having to make monthly payments.

For example, say you need to end up with £50,000 in the bank and you have a property worth £100,000. If we imagine that the total interest cost comes to £10,000 and the fees are £2,000, you could ask for a total loan (or gross advance) of £62,000 (62%). That way, after deducting the interest and fees, you’d end up with a net advance of the £50,000 you need.

This wouldn’t work so well if you wanted to end up with £70,000 in the bank – because most lenders’ maximum LTV is 70%. After borrowing £70,000 and deducting the interest and fees, you’d end up with much less.

Rolling up the interest maximises the amount of money you get at the start, and saves you from making monthly payments. However, you end up paying more interest in total because it compounds during the loan term: effectively, your loan is increasing month-on-month which increases your interest payments.

For example, the repayments on a 12 month, £100,000 loan with interest charged at 0.75% per month will be £750 per month. Each month that you don’t actually pay this £750 (because you’re rolling it up), it gets added on to your balance: so the first payment will be £750, the second will be £755.63 (0.75% of £100,750), and so on.

As a result of this compounding, the total interest payable at the end will be £109,380.09 – compared with £109,000 if you hadn’t allowed it to roll up (in other words, you’d either withheld it or serviced it).

If you want to roll up, the lender will generally want the amount you owe at the end to fall within their LTV limit. So in the example above, you’ll end up owing just over £109,000. If their maximum LTV is 70%, your property would need to be worth at least £157,000 to support this £109,000 debt. On the other hand, if you made monthly payments instead of rolling up, you’d only owe £100,000 at the end so the property would need to be worth £143,000.

Servicing the interest is a good option if you’ve got the monthly cashflow to do so, because it doesn’t reduce the amount you can access at the start (like withholding) or compound your interest payments (like rolling up).

Servicing also allows you to take out a longer loan term, because if you opt for a 12 month rather than 6 month term (for example) you don’t end up with less at the start (because of more interest being deducted) or your overall borrowing being reduced (because of the rolled-up interest needing to fit inside the LTV cap).

There’s no “best” way to treat the interest – if you’re given the choice, the right option will depend on your circumstances and what you want to achieve.

Although you’re paying for the lender’s solicitor, you’ll also need to pay for your own solicitor to act for you. If you’re buying the property (you don’t already own it), the solicitor acting for you in the purchase will handle the lending element too.

The lender will ask your solicitor to send over all the information they usually obtain in the course of buying a property: searches, insurances, checks of the Land Registry, and so on. The lender’s solicitor will then double-check all this information, raise enquiries about anything that’s missing, then eventually approve the loan to be released.

At this point, your solicitor can exchange and complete on the transaction – with the lender sending the funds over in time for completion day.

This can all be done very quickly: it’s technically possible to complete a bridging transaction in under a week, which would never happen with a mortgage. That’s because there are so many elements that a mortgage lender will definitely want to look at (like your income and employment status), which a bridging lender will either ignore or look at in less detail.

A week is seriously pushing it though, and a few weeks or a month is more typical. The speed will be dictated by a number of different factors:

• How long it takes to get an appointment for the valuer to go out, and how long it takes him to send in his report
• How quickly your solicitor works to send across the information the lender requests, and to respond to their queries
• Whether you have all the information the lender needs, like local searches
• How quickly the lender and the lender’s solicitor work
• How much digging the lender wants to do into factors relating to you rather than the property
• In the case of second charge loans, how long it takes the primary lender to approve the loan

There can be huge variations depending on circumstances: I’ve been involved in bridging transactions that have taken about a week, and others that have dragged on for months. If you have a firm deadline (like in the case of an auction purchase), make sure the lender and your solicitor are both aware of this at the start. And like anything involving solicitors, don’t expect much to happen unless you’re chasing constantly.

In general though, given identical circumstances, some lenders are just faster than others. And – surprise surprise – the ones that are faster tend to have higher rates and fees.

• Can you benefit enough to offset the costs?Work out the profit of your project after factoring in the borrowing costs to determine whether it still makes sense.In the case of a flip, that’s easy: deduct the finance cost along with your construction and other costs. For a property you intend to hold, make sure the discount you’re getting for speed is greater than the higher costs relative to just getting a mortgage.
• Do you have a good exit strategy?You do not want to get stuck on a bridge. Because the costs are high, even if you can extend the term at the same rate it will still eat into your profit margin quickly. Usually, lenders will increase the rate or impose extra costs if you overrun.For that reason, being confident that you have a good exit strategy and you can execute it within the loan term is critical. Make sure the term you take out is long enough, even if things don’t go perfectly: it will always work out cheaper to take a longer term initially than to try to extend it. Ideally, use a lender who doesn’t penalise you for early repayment – so you can err on the safe side with the loan term, but still get out early if all goes as planned.Also make sure you’ve got a get-out plan even if things go wrong. If the property isn’t selling, for example, can you cut the price to a level where it will definitely sell quickly and still break even? Or if you plan to refinance but the mortgage market has suddenly dried up, will you be able to sell it instead?
• What’s more important: the best terms or the best rates?As we’ve already seen, the cheapest overall cost of bridging will be available in circumstances where the lender won’t lend you as much relative to the property’s value, is pickier about your personal circumstances and track record, or is slower.There are lots of lenders and plenty of choice – so in any given situation you can decide what’s more important to you, and pick your lender accordingly.

Your next steps

As I said back at the start, people are confused and scared about bridging loans.

Hopefully you’re no longer confused. And you shouldn’t be scared either – as long as you know what you’re doing, and you’re confident in your exit strategy. It’s a powerful tool: dangerous in the wrong hands for sure, but it will help you to get great results if you know how to use it properly.

You might choose to look for projects specifically where you can use bridging to get a good deal – allowing you to compete with cash buyers. Or now you’re confident in what bridging is all about, you can have it as just another item in your toolkit to pull out if the right circumstances happen to come along.