More and more people are taking out bridging loans, but they are not cheap and they can be risky.
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What is a bridging loan?
It’s easiest to explain what a bridging loan is with a practical example. A family wants to move to a bigger home or to another property because there’s been a change of job. They’ve found the right property, but the sale of their own home has just fallen through.
Now they are in danger of losing their new home if they don’t commit to buy it, plus they’ve already committed significant money upfront for a survey, mortgage and other fees.
A bridging loan is an option, as it will allow them to borrow money to pay the mortgage of their new home while they continue to try to sell their current property. As the name implies, the loan will bridge the gap between the sale of their home and the purchase of their new one.
This type of bridging loan is a secured loan, as your property is at risk if you don’t keep up the repayments on the loan.
Property investors may also use them to secure the purchase of a property while they organise the finance for it. If the loan is not secured against an owner-occupied property, it is not regulated by the Financial Services Authority (FSA).
The Council of Mortgage Lenders says that some bridging loans are now being offered for up to three years to investors but they are primarily designed as a short-term option, which is why they differ from second charge mortgages.
Types of bridging loan
There are two types of bridging loan: a closed bridge and an open bridge.
Closed bridging loans
Closed bridging loans are for people who have already exchanged contracts on the sale of their home, so there is very little chance of it going wrong.
Open bridging loans
Open bridging loans can be taken out even if you haven’t put your home up for sale. The lender will usually want evidence that there’s plenty of equity in your current home, so that you’ll be able to pay off the loan once you sell.
They are usually ‘open’ for no longer than 12 months, although they may be renewed if repayments have been made on time and it looks like the sale or finance may be completed in the future.
What do they cost?
Interest rates on bridging loans are usually far more open to negotiation than for standard mortgages.
However, the rates quoted are often monthly, for example 0.75%-1.5%, so they may look cheap but in actual fact are far more expensive than standard mortgages. You should always ask for the annual rate as a point of comparison, particularly if you’re taking out a loan for longer than a few months, and make sure you shop around. Many bridging loans are only offered via mortgage brokers, so you might find it better to use one than do the search yourself. Be aware that you will be charged a fee if you use a broker.
Annual rates can be more than 10%, compared to 3%-5% on standard mortgages.
You should also watch out for fees, which can include facility and/or establishment fees (basically admin fees), valuation fees, legal fees and even exit fees if you repay the loan early. Check the terms of any contract carefully to see what fees are being charged.
Pros of bridging loans
- They can provide a short-term source of finance, usually more quickly than if you were to apply for a standard mortgage, to help with a property purchase.
- They are usually short-term loans and can often be repaid early without penalty. You should check for any early repayment fees before you sign up.
Cons of bridging loans
- Your home is at risk if you don’t keep up repayments on a bridging loan.
- If you’re borrowing for a longer period of time, the interest charges are much more expensive than a standard mortgage.
- There are usually several fees which you will also have to pay.
- Some loans are not regulated by the Financial Services Authority so it may be difficult to get compensation if something goes wrong.
Alternatives to bridging loans
If you’re having trouble repaying your mortgage, you should talk to your lender before you even consider a bridging loan as an option. They may be able to offer you a payment holiday, lower repayments for a period of time or even extend the term of the mortgage while you get your finances straight. There are more tips in What to do if you're at risk of repossession.
If you’re struggling to sell your current home but you’ve found a new property, you may be able to change your current mortgage to a buy-to-let mortgage and rent out your home while you continue to try to sell it.
You’ll need to do your homework in terms of rental demand and how much rental income you can expect. You should work out whether this would be enough to cover your mortgage, other expenses such as maintenance, and potentially provide a ‘cushion’ for any period when you can’t rent out your home. Find out more in How to rent out your home.
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This article aims to give information, not advice. Always do your own research and/or seek out advice from an FSA-regulated broker (such as one of our brokers here at lovemoney.com), before acting on anything contained in this article.
Finally, we tend to only give the initial rate of a deal in our articles, but any deal which lasts for a shorter period than your mortgage term may revert to the lender's standard variable rate or a tracker rate when the deal ends. Before you take out a deal, you should always try to find out from your lender what its standard variable rate is and how it will be determined in the future. Make sure you take all this information into account when comparing different deals.
Your home or property may be repossessed if you do not keep up repayments on your mortgage
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