In the world of property development bridging loans are often an extremely useful method of obtaining short term finance in order to either secure a property or refurbish with the intention of adding value. Traditionally bridging loans can attract interest of up to 20% (or even higher) depending upon the type of security offered, type of project, size of the loan and the loan to value ratio (LTV). On the surface the interest rate may seem extremely high but the key is how this money is used and the return it creates.
Refurbishments, renovations and redevelopments
The easiest way to show how bridging loans can assist with refurbishments, renovations and redevelopments is to give you an example.
Property acquired for £100,000 in cash
In this example a property is acquired for £100,000 with the idea of refurbishing, renovating or redeveloping. The investor takes out a £50,000 bridging loan with an interest rate of 20% (equating to 1.67% per month) for a period of 6 months. The idea is that the £50,000 investment used to fund refurbishments, renovations or redevelopment will add an additional £100,000 to the value of the property resulting in the net gain shown below:
Six monthly interest payments at 1.67% per month = £5010
Typical lender’s fee at 2% = £1000
Typical broker’s fee at 1% = £500
Therefore, at the end of the six-month period the £50,000 will be repaid having attracted interest charges of £5010 and additional charges of £1500. Depending upon the nature of the project there may also be additional legal charges.
However, in theory we now have a property worth £200,000 which cost:
Original purchase price £100,000
Bridging loan £50,000
Bridging loan interest plus expenses £6510
Total expenditure £156,510
Mortgaging at a higher value
It is now possible for the investor to take out a traditional long-term mortgage, at lower interest rates, on the new property value of £200,000. The funds raised on the higher value can be used to pay off the bridging loan where in simple terms a £56,510 investment has created £100,000 in enhanced property value.
All bridging loans will require some kind of security which is traditionally a property owned by the investor. This ensures that in the event of financial problems in the future the bridging loan can be paid off by disposing of the secured asset. As an investor is obliged to use one of their own/company assets as security against the bridging loan this ensures that they have the strongest incentive to fulfil their financial obligations.
Bridging loan charges
As we touched on above, bridging loan charges can add a significant amount to any bridging finance and this is something that investors need to be aware of. In recent times we have seen challenges to the traditional bridging loan market in the shape of crowdfunding bridging loan operations which effectively link investors directly with borrowers. Some of the benefits of crowdfunding bridging loans include:
• Reduced additional expenses with specific focus on crowdfunding bridging loans in theory attracting increased volumes.
• Reduced operating expenses and third-party commissions have led to a fall in traditional bridging loan interest rates. In simple terms, crowdfunding reduces the layers of bureaucracy.
• More attractive repayment options with many crowdfunding deals offering early repayment with no additional charges.
Crowdfunding bridging loan companies still require the same level of security as more traditional bridging loan companies. However, they take full advantage of the online market thereby reducing their own overheads leading to reduced charges for customers. As we have seen with private loans, business loans and property development finance, crowdfunding is putting significant pressure on more traditional rates of interest.