Of the many lethal property strategies that can make shrewd investors a killing, use of bridging loans is one of the most fundamental and is something most property investors are likely to come across at some point in their property career.
A bridging loan can be used to achieve a number of property goals and profit sources.
It is however a strategy which comes with a high number of serious risks and should only be used by inexperienced investors after taking suitable professional advice.
1. The nature of a bridging loan
A bridging loan is basically a short term commercial loan, typically up to a year in length, with the primary security for the loan being a property, with relatively little relevance being attributed to the credit status of the borrower.
The term “bridge” hails from the fact that characteristically such a loan is provided to enable a borrower to bridge the gap between:
- A point or stage where the borrower does not have the funds they need and
- A point or stage where the borrower will have the funds they need.
2. Examples of where a bridging loan can be useful
A buyer agrees to buy a property at an auction and cannot secure a regular mortgage in time to complete within 28 days as required by the auction contract.
The buyer needs a loan to bridge the period from the date they must complete until the date regular mortgage funds are received.
A homeowner is selling their home and buying another home. They need some of the money from their sale to complete their purchase.
For reasons beyond their control, the sale cannot go through on the anticipated date and will be a few weeks late. However, such a delay would mean losing the property they want to buy.
The solution is for the homeowner to secure a bridging loan from the date they complete on their purchase to the date they complete on their sale.
- In the first example a bridging loan is used to prevent, stop or reduce losses – to save money.
- In the second example a bridging loan is used as a practical device to achieve a desired objective.
A bridging loan can also be used creatively – as a way to make money, profits or gains – as a property investment tool.
This is where a bridging loan is at its most interesting and exciting for property investors looking at ways to stretch their money, to use it more effectively, to go further with less.
MUST KNOW PROPERTY STRATEGIES
Rent to buy (property is rented before it is bought)
Delayed completion (completion is delayed to make a profit)
Seller finance (the seller helps a purchaser to buy)
Option to purchase (a device to control and profit from property)
3. Buying with a bridging loan and adding value
One way for you to make money using a bridging loan is to buy a property partly or fully with the aid of a bridging loan, add value to it and then secure a regular buy-to-let mortgage to pay off the bridging loan and attendant costs – leaving you with a property with equity and the opportunity to collect a rental income.
The degree of success you will achieve, the amount of equity and net rent you secure, will be determined by the extent to which the property was a bargain when you bought it and the amount of value you are able to add.
There are many ways value can be added to a property after it has been purchased and is being held with the aid of a bridging loan, including:
- Obtaining planning permission
- Refurbishing kitchen or bathroom
- Adding an extension or carrying out a loft conversion
- Adding a conservatory
- Converting into two or more units
- Splitting the title
- Extending a short lease
- Changing the use, for instance from commercial to residential.
4. Practical example
Here is an example of how a bridging loan could be lucratively employed to acquire a property at zero cost ultimately.
Yaya finds a flat which is in an appalling condition but will be worth considerably more when done up. He is getting an exceptional bargain because the seller needs to sell fast and is prepared to take a hit.
The purchase price is £180,000. Yaya will take out a bridging loan for £180,000, and will buy the property as if he is a cash buyer. The bridging loan is effectively a short term mortgage.
Yaya will pay bridging loan interest and charges, legal and professional charges and refurbishment costs (£45,000 in total) from his savings. He does this to keep down the size of the bridging loan since it is generally a very expensive form of borrowing.
After refurbishment the property will be worth £300,000. The total cost of the purchase comes to £225,000 (£180,000 plus £45,000).
Upon completion of works, the property values up at £300,000 as anticipated and Yaya manages to secure a 75% loan giving him £225,000 – the same amount as the grand total he spent in acquiring the property. He pays off the bridging loan and gets back the £45,000 he spent from his savings.
He is left with a property (with equity of £75,000) which he can rent out, with the rent paying his mortgage and a bit left over.
HE HAS ACQUIRED AN INCOME EARNING PROPERTY WITH PROSPECTS OF FUTURE CAPITAL GROWTH AT ZERO COST TO HIMSELF. AND ALL BECAUSE OF A BRIDGING LOAN.
All figures are of course illustrative only.
5. The pitfalls of a bridging loan
A bridging loan is a good example of the property maxim “high reward, high risk”.
A bridging loan typically has a range of risks, dangers and disadvantages, including:
- Generally it is significantly more expensive than a regular mortgage in terms of fees, interest rates, charges and penalties
- The terms and conditions of a bridging loan agreement can be onerous even unfair and borrowers should never let their need or desire for the money cloud their judgement
- If the loan is required for longer than calculated due to circumstances beyond your control and you are unable to meet payments, you will be in breach of the loan agreement and a plethora of charges, fees, penalties and costs – including the possibility of insolvency proceedings – can kick in hard and fast
- Failure to pay sums due can lead to the property or properties against which the bridging loan is charged being possessed and sold; if that property is your home, the consequences are especially grave.
Because of the severity of the impact if there is a breach of a bridging loan agreement, it is highly desirable to have a Plan B, and ideally a Plan C, for meeting your financial obligations in the event of unexpected delays or setbacks.
When structuring a bridging loan strategy, it is often recommended that you should add 25% extra throughout in terms of all elements of time or money involved; in other words, you should conservatively err on the side of caution.
Have you ever used a bridging loan? What were your experiences? Please leave your comments below.
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