Bridging loans: the risky finance that could cost homebuyers?
The Guardian has reported that demand for costly short-term bridging loans in increasing in the middle of the credit crunch.
The mortgage industry may still be recovering from the effects of the credit crunch, but in one often-overlooked corner of the market business is booming.
Demand for bridging loans – short-term secured loans designed to bridge a temporary cash shortfall when buying a property – has surged, say experts.
The loans are usually taken out to help someone buy their next property if the sale of their existing one hasn’t been completed. Many would-be home movers have fallen foul of one of the problems afflicting the property and mortgage markets, and are keen to do whatever they can to prevent their deal falling through.
Others include those buying a house for which they can’t get a standard mortgage because it requires major work to make it “habitable”, and those snapping up cheap properties at auction who need to sort out their finance quickly.
The downturn has brought bridging finance more into the mainstream but, as the Council of Mortgage Lenders (CML) says, it is “clearly not the answer to anything other than a minority of financial problems”.
Melanie Bien at mortgage broker Private Finance says bridging finance has its uses, but adds that if you don’t have a realistic exit strategy, such as a buyer lined up for your own property, “bridging is extremely risky and should be avoided at all costs”. If, for any reason, the sale of your existing house does not go through, you could be stuck with an expensive loan for a long time.
Nevertheless, this is a growing area. Last month, the CML issued a list of the 30 lenders that did the most mortgage business in Britain last year. Placed 21 was a name few will have heard of: bridging finance specialist Tiuta.
It was recently predicted that bridging lenders will be making gross loans to the tune of £1bn by the summer of 2013. That forecast came from another firm, West One Loans, which put the market’s current value at more than £750m a year. But you may find you can sort out your problem without resorting to a bridging loan. Talk to your bank. If the shortfall isn’t too vast, there may be other options.
So what’s available and what will it cost? Guardian Money tracked down the deals to answer your questions.
How long do they last? The term can be from one day to a year or more, depending on the provider. Typically, you would have the loan for a few months.
How much do they cost? As you might expect, it’s an expensive option, though competition has brought the costs down a little.
The borrower usually pays monthly interest. Rates typically start at 0.75% a month, rising to 1%-1.5%, says Ray Boulger at mortgage broker John Charcol. While companies have their published rates, these are often more negotiable than standard mortgage rates. Tiuta has a rate of 0.89% for properties within the M25.
If you were borrowing £250,000 at a rate of 0.89%, you would pay £2,225 a month. However, this would still be equivalent to an annual rate of more than 10% – way above standard mortgage rates.
A lot will depend on your “loan-to-value” (how much you are borrowing as a proportion of the property’s value) and whether it is a “first charge” or “second charge” loan (see later). It also depends whether or not you have exchanged contracts.
Any other costs involved? Yes, there will be fees, and these can vary greatly. Quite often they will run into thousands of pounds. Boulger says the interest rate is often less important than the fees, particularly if you only expect to have the loan in place for a couple of months. “It may be worth paying a higher interest rate to get lower fees,” he says.
Tiuta, for example, charges a “facility fee” of 1% of the loan amount (£2,500 in the above example), plus a £495 administration fee and £495 legal fee. With Masthaven, another leading provider, you pay a 2% arrangement fee, plus a valuation fee of between £245 and £995, and legal fees (minimum £500) on top of its 1.25% a month flat-rate interest for all residential first-charge lending.
Also watch out for exit fees – most bridging loan companies don’t impose them, but some do.
Bear in mind that if you use a mortgage broker, they will charge a fee, too. Boulger says that with so many bridging loan specialist firms out there, and the huge variations in deals, this is one area where using a good independent broker can make all the difference.
Are bridging loans regulated by the Financial Services Authority like traditional mortgages? Yes and no. What often happens is that someone taking out a bridging loan has some equity in their existing home. So, to increase the amount they can borrow, they get a “first charge” loan on the property they are buying, and a “second charge” on their existing home .
To complicate matters, first charge loans of this type are regulated by the FSA, but second charge loans aren’t (the latter also applies to first charge loans secured on buy-to-let investment properties). Companies that are not regulated can’t offer first charge residential bridging finance.
Should I only use a company that is regulated by the FSA? Some might argue that a regulated company might be expected to be more professional, but that would probably be unfair to some of the providers that aren’t regulated but do provide a good service, says Boulger. Companies that are only doing second charge loans or who concentrate on buy-to-let don’t need to be regulated, he says.
How many companies offer bridging loans? “There are around 40 lenders in this market, but a mainstay of around 10 who do the bulk of lending,” says Bien. Others, in addition to those named above, include Cheval, Dragonfly and Precise Mortgages. Some high street banks will offer bridging, but they are not specialist in this area, so pricing can be prohibitive, adds Bien. “It is a specialist area, so needs a specialist appetite and specialist approach to underwriting.”