Since the financial crash in 2008, banks and building societies have become stricter with their lending policies. As a result, there has since been an influx of bridging loan lenders into the property market. Here, we take a look at what bridging loans are, how they work and why you might get one.
What Are They?
Bridging loans are designed to assist people who are looking to purchase a home, but who are yet to sell their existing property to fund their new transaction.
They are short-term funding options, designed to bridge the gap between the completion of one’s purchase and sale endeavours. They can also be used to help those buying at auction or those looking to sell their properties shortly after renovating them, to increase their value.
As a result, they can be a valuable tool that can facilitate the purchase of property that otherwise would not be achievable.
Types of Bridging Loans
There are a number of different types of bridging loans. The main differences in their features are:
• Fixed and variable rates
A fixed rate loan means that the monthly repayments are set in advance, with the unchanging interest amount applicable throughout the course of repayment.
Whereas, a variable rate loan means that your interest rate is subject to change, so your payments could increase or decrease as time goes on.
• First and second charges
When you sign-up for a bridging loan, you will be told whether it is a ‘first’ or ‘second’ charge – each denoting who would have priority of repayment, should you default on the loan.
If you pay for your new property with a bridging loan, but have a mortgage on your existing property, your mortgage will be a first charge loan against your current home. The bridging loan may be a second charge loan on your current property, meaning that it will also take your current home as security, but your mortgage will take priority for repayment should your home be repossessed.
If you were to use the bridging loan to repay your current mortgage, thus settling your mortgage with your lender, then the bridging loan will be registered as a first charge loan.
In any instance, your loan documents will outline whether the loan is a first or second charge; as well as which property the loan will use as security.
Who Are They Aimed at and How Much Can They Cost?
Bridging loans are aimed at landlords and small-scale property developers, including those purchasing at auction, a situation wherein a mortgage is needed quickly.
For example:
A couple are looking to sell their existing leasehold property, on which they have an outstanding £100,000 mortgage.
In the middle of the process, they have taken to a new property, costing £400,000, but the seller will only consider their offer if they exchange contracts within four weeks. They are part of a chain on their sale and so the sellers’ terms are unrealistic if they are to wait for the proceeds of their sale to fund their new purchase.
They need to borrow the £400,000 to purchase the property, before another buyer is found. Conventional mortgage lenders (banks and building societies) will not lend to them because their annual income is not high enough; instead, they take out a bridging loan.
However, this short-term convenience means that bridging loans are substantially more expensive than standard loans. Interest rates on bridging loans, as well as their associated administrative fees, can be high; and you could pay up to 1.5% a month (or 18% APR) on top of the amount that you initially borrowed. This is then in addition to the administrative costs for arranging and exiting the loan, which can be around 1% each.
In the example scenario above, these charges would add £8,000 to their £400,000 loan; with the agreed interest rates also then applicable.
How Are They Regulated?
If your loan is secured by a first or second charge, it is likely that the loan will be regulated by the Financial Conduct Authority (FCA). However, the type of charge attributed to your loan will determine how it is regulated.
The creation of the Mortgage Credit Directive in March 2016 brought about the divide in the FCA’s regulation of first and second charge mortgages. As a result:
• First charge mortgages are regulated the FCA’s Mortgage Conduct of Business regulations; whilst,
• Second charge mortgages are overseen by the FCA’s Consumer Credit rules.
Please be aware that if you are purchasing a commercial property or as a business, these rules may change.
How Can We Help?
At Howells, we have an experienced legal team who will be able to help you with the legal aspects of your bridging loan. We understand that the experience can be daunting and will be there to help you every step of the way.
We always recommend speaking to a financial advisor before applying for a bridging loan, as they will be able to best assess its suitability to your needs. With the high interest rates and charges applied to them, bridging loans can end up as costly mistakes in the wrong circumstances. Bridging loans can be beneficial, in the right situations; however, a remortgage or a personal loan might better suit your requirements.
To speak to one of our dedicated legal experts, call 02920 404020 today. Alternatively, please leave us a message through the ‘Get in Touch’ section at the bottom of this page and one of our team will contact you as soon as possible.
