What is a bridging loan?

Are you stuck between selling your old home and buying a new one?

A bridging loan might help you cross that gap. Let's learn all about bridging loans in simple terms.

What is a bridging loan?

A bridging loan (also known as a bridge loan) is a special type of short-term loan that helps you ‘bridge’ the gap when you need money quickly.

People often use bridging loans when they want to buy a new house before selling their current one. The loan gives you the money to buy your new home while you wait for your old home to sell.

Bridging loans are much faster to arrange than mortgages. You can sometimes get the money in just a few days. But remember, they only last for a short time – usually between 1 month and 2 years.

How does a bridge loan work?

Bridging loans work differently from mortgages. Here's how they work:

1. You apply for the loan with a specialist bridging lender.
2. If you're accepted, the lender gives you the money as a lump sum.
3. You use this money to buy your new property or whatever else you need it for.
4. You pay back the loan when your old property sells or when the loan term ends.

Bridging loan interest rates

Bridging loans have higher interest rates than mortgages. This is because they are short-term and involve more risk for the lender.

The interest rates usually range from 0.5% to 1.5% per month. This might not sound like much, but it adds up to 6% to 18% per year! That's much higher than a mortgage.

Bridging loan example

Let's look at a simple example:

Arthur wants to buy a new house for £300,000. His current house is worth £250,000 but hasn't sold yet. He has £50,000 in savings.

To buy the new house, Arthur needs a bridging loan of £250,000. The lender charges 1% interest per month.

If Arthur takes 6 months to sell his old house, he'll pay:

• Loan amount: £250,000
• Interest: £250,000 × 1% × 6 months = £15,000
• Total to repay: £265,000

When Arthur sells his old house, he uses that money to pay back the bridging loan. This example is simplified and doesn't include fees, which we'll talk about next.

How much does a bridging loan cost?

Bridging loans come with several costs:

1. Interest: As we've seen, this is usually between 0.5% and 1.5% per month
2. Arrangement fee: Usually 1-2% of the loan amount
3. Valuation fee: The cost of checking how much your property is worth
4. Legal fees: You need a solicitor to handle the legal work
5. Exit fee: Some lenders charge a fee when you pay back the loan (around 1%)
6. Broker fee: If you use a broker to find your loan, they might charge a fee

Bridging loan for house purchase

Using a bridging loan to buy a house is the most common reason people take out these loans. Here's when it might make sense:

• You've found your dream home and don't want to lose it
• Your house sale has fallen through at the last minute
• You're buying a property at auction and need the money quickly
• You're buying a property that isn't in good enough condition for a mortgage
• You want to break a property chain to make your purchase more attractive to the seller

💡 Remember: Using a bridging loan can mean you'll temporarily own two properties. Make sure you can afford all the costs, including two lots of council tax, insurance, and utilities.

How to get a bridging loan

Getting a bridging loan is faster than getting a mortgage, but there are still steps to follow:

1. Speak to a specialist broker: Bridging loans are specialist products, so talk to a broker who understands them.
2. Have a clear exit plan: Lenders want to know exactly how you'll pay back the loan.
3. Prepare your documents: You'll need proof of ID, proof of address, details of the property you're buying, and details of how you'll repay the loan.
4. Property valuation: The lender will check how much your current property and the property you're buying are worth.
5. Get legal advice: Always use a solicitor who understands bridging loans.

The process can take as little as 7-14 days from application to receiving the money.

The risks of bridging loans

Bridging loans can come with serious risks which you need to understand. The high interest rates can quickly add up if your exit plan falls through. If you can't sell your property or secure other financing in time, you might face expensive extension fees or even repossession.

The short-term nature means you'll have less time to sort out problems, and the large fees upfront can significantly increase your debt. Always have a solid backup plan before taking this financial step.

Alternatives to bridging loans

Because bridging loans are expensive, it's worth looking at other options:

• Sell first, then buy: The safest option is to sell your current home before buying a new one. You could move into temporary rented accommodation in between.
• Family loan: If possible, borrowing from family members is usually cheaper than a bridging loan.
• Traditional mortgage: Some lenders offer special short-term mortgages that can help you move house without needing a bridging loan.

Should I get a bridging loan?

Bridging loans can be very useful, but they're not right for everyone. Ask yourself these questions:

• Do I have a clear plan for paying back the loan?
• Can I afford the high interest rates and fees?
• Have I explored all other cheaper options?
• What will happen if my exit plan fails, e.g., if my house doesn't sell?
• Is the property I want to buy worth the extra cost of a bridging loan?

Bridging loans work best when:

• You only need the money for a short time - ideally less than 12 months
• You have lots of equity in your current property
• You're confident your current property will sell
• You need the money quickly
• The opportunity is worth the extra cost

Remember, bridging loans are powerful tools, but they come with risks. Always get professional advice before taking one out.