Bridging Loans – The Risks
Bridging loans are a fantastic source of fast property finance for investors and developers. Like a mortgage but shorter term and quicker to arrange these loans help people to scale their businesses, buy property that is in a poor state of disrepair, and close deals quickly. They are also used when residential clients are stuck in a chain and need to bridge the gap between completions. They are versatile and effective but like any loan, there are risks involved which need to be considered from the outset.
Like mortgages, bridging loans are secured against your property so you are at risk of losing your property if you do not pay the loan back in time. Unlike a mortgage, a bridging loan generally lasts for less than 1 year and normally interest payments are all paid back at the end of the loan along with the capital in one lump sum.
Open to all– These loans are open to a wide range of property professionals from sole traders and partnerships to limited companies. Lenders are a lot more accommodating than traditional banks and mortgages and will consider all types of property and personal circumstances including those clients with bad credit.
Fast Turnaround– You do normally have to go through a credit check, anti-fraud checks and you have to have a RICS valuation completed on the property. But the whole process is a lot quicker than getting a traditional mortgage and can often be completed in 3-4 weeks and sometimes in a few days, rather than 3-6 months like most mortgages.
Versatile– From chain breaks to auction purchases, below market value acquisitions and refurbishments. Bridging loans can be used to finance all sorts of property transactions. Often, they are used to purchase property in poor condition and then refurbish them to a point at which a traditional mortgage lender will lend against it.
Non Payment- Late payment will normally initially result in a default interest rate being charged. This is usually 2-3% per month and can be higher. If you delay repayment for long these rates can take all the profitability out of a deal very quickly. Ultimately the next step if you could not repay would be repossession of the property. It is therefor important that you factor in contingency into timescales and try to have a second exit lined up. So, if you have a 3 month refurb and then sell the property, take a term of 6 months or more on your bridge. If your primary exit is to refinance also be prepared to sell and check that the figures work on the secondary exit.
Breach of conditions- Like all loans there are various conditions that you sign up to and need to adhere to when taking out a bridging loan. Breaching conditions could result in extra charges or even an immediate cancellation of your facility. One common condition is that if you are refurbishing a property to sell, you won’t be allowed to rent any part of the building out whilst your loan is in place. This is because it can be very hard to sell a property with tenants in situ.
Unrealistic valuations- When you take out a bridging loan you will need to pay for a RICS valuation. These reports tell you how much your property is worth in terms of open market value and often 90 day valuation and 30 day valuation, taking into account a shorter marketing period if the property needs to be sold quickly. If you over estimate a properties value, you will end up getting stuck when the valuation comes back lower and need to find more money to put into the deal. Equally on the exit of the loan if you are refinancing out you must make sure you get the end value you were hoping for. Cutting corners on a refurb whilst you are on a bridge could result in a low valuation and when you come to refinance and you getting stuck on the bridge paying high interest rates or even losing the property.
How to Mitigate the Risks – Exit Exit Exit
You need to make sure you are never in a position where you get stuck on a bridge. Occasionally it is unavoidable not to roll the term a little and if you are open and honest with your lender they will normally grant you a few weeks or even months to get your project finished. The last thing any lender wants to do is repossess a property, it is a costly and complex legal process. So, get a solid exit in place before you take a bridge out or even better 2-3 exits. These exits could include sale of the property itself, cash coming in from another source or a refinance.
Sale- If you are looking to sell the property in order to pay off the bridge do plenty of market research on recently sold properties and make sure there is a demand. This can be done for free on rightmove sold prices and by checking with local agents. Make sure there is headroom in the deal allowing for a quick sale at a little discount if needed.
Money from an external source- If this is how you are repaying the loan then always make sure you could use a sale or a refinance as a backup. Things can change suddenly and if you are waiting for another sale to go through or a payment to come in, you never know what delays and obstructions may crop up. Always make sure the project stacks up for a sale or a refinance too, just in case.
Refinance- If refinancing onto a BTL you can normally take a mortgage of 75% loan to value. This means that you need to keep the total cost of the bridge below that 75% mark to avoid topping up the mortgage to pay off the bridge. Remember to consider legal fees, valuation fees, broker fees and arrangement fees which are often applicable. And make sure the rental figures work as lenders want to see 125% or more rental coverage above the cost of the mortgage payments.
If you have a solid exit in place backed up by a secondary exit you will be able to confidently build your property business utilising bridging finance.