Short-term liquidity is often sought after in the United Kingdom (UK) when looking to complete a real estate deal in an expeditious manner. Bridging loans can serve as a source of this liquidity by providing flexibility suited to address constrained timelines.
This article will detail an outline of how bridging loans work, the drivers of their pricing, who benefits most, key differences in residential bridges, and common pitfalls.
How bridging loans work
A bridging loan is a short-term product secured against a property that offers speed and flexibility by giving the borrower time before selling or refinancing. Consequently, the costs of a bridging loan are typically higher than that of a mortgage or term product. Usually, a bridging loan will hold a first charge over your property, however a second charge is possible depending on how much equity sits in the structure of the deal. As a short-term loan, bridges are typically three to eighteen months in length, although a twenty-four-month bridging loan is not uncommon. Pursuant to its theme of flexibility, the interest in a bridging loan can be rolled up or serviced monthly. This provides room to the borrower if they expect large cash inflow in the future by rolling up the interest to the end of the loan term and repaying the facility when they have stronger liquidity. The leverage provided by a bridging loan often depends on the borrowers’ profiles, credit history, experience, or portfolio composition. A seventy five percent Loan-To -Value (LTV) is common in the UK bridging market, and many lenders also base the level of leverage they are willing to provide on Gross Development Value (GDV). The speed by which funds are drawn down to the borrower can be swift, often in as little as two weeks, with auctions even quicker to meet constrained timelines.
What Drives Pricing
As with any interest-bearing product in the financial market, the rates associated with bridging loans will move in tandem with market rates which largely stems from movements in the Bank of England Base Rate. Notwithstanding, the rates charged for bridging finance rest upon on a variety of other factors, the Base Rate simply exists as a benchmark before pricing in idiosyncratic risks associated with the loan.
One of the major factor’s lenders assess is the exit strategy which centres around how the loan will be repaid. Lenders prefer to see a clear exit strategy with predictable future cash flow to safeguard against the risk of default whether it’s measurable future sales or evidence of refinancing ability. The quality of the asset is another major determinant factored into pricing as the lender likes to see tangible evidence that aligns with the monetary value they are assigning to it. Naturally, as the leverage present in the deal increases, pricing will adjust accordingly with higher rates associated with a higher Loan-to-Value. If speed is a priority for the borrower, the lender will often adjust their pricing to accommodate for the risk stemming from an expediated application as well.
Who benefits most
Those in time-constrained environments aiming to seal a transaction stand to benefit most from a bridging loan. This often includes those needing finance for an auction, developers in need of liquidity to finance refurbishments, conversions, or exit a development loan, individuals or firms stuck in a broken chain (timing gap between expected sale and current purchase requirements), or holders of a portfolio who require refinancing of their properties from existing debt.
Residential bridging
An important distinction to recognise exists when you require a bridging loan secured against your main residence in which occupy. In these instances, the loan becomes regulated resulting in enhanced consumers protections, an increased prescriptive process, and consequently a more complex process in securing the funds necessary. As a result, lenders can become deterred if you require a regulated bridging loan.
Common pitfalls
Bridging loans are attractive forms of financing for many, however, there persists a few scenarios in which consumers are faced with difficulty accessing the financing they need. An unclear exit strategy is a typical misstep causing an obstacle in the application process. Furthermore, borrowers assign optimistic timelines to their projects causing strained cashflow when nearing the end of their loan term. Finally, it is imperative to formulate a comprehensive understanding and organised approach to the legal work to avoid hurdles down the line.
Considering the evidence provided, bridging loans offer solutions to consumers in the UK by serving as a quick form of financing to provide the liquidity you need in pressurised real estate environments. Nevertheless, it is imperative to consolidate your understanding of this attractive product by recognising its pricing mechanics and common stumbling blocks.
