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Bridging loans for landlords: how do they work?

Posted on 2016-07-15

As the Private Rented Sector (PRS) has grown so rapidly in recent years, more alternatives to traditional buy-to-let lending have emerged, helping landlords to make property purchases.

According to the most recent English Housing Survey, the PRS accounted for 19% of 22.5 million households in 2014-2015.

That's a lot of rental properties and not all of them will have been acquired through traditional channels. There are more landlords than ever before and so it stands to reason that there will be a wider scope of financial backgrounds and requirements in the market.

One type of finance to benefit from the growth of the PRS – as well as increased regulation and legislation – is bridging loans.

Bridging loans are a short-term finance solution which, as the name suggests, help landlords and investors to bridge a funding gap in order to purchase or renovate a property.

As recently as 2012, the bridging sector was still relatively small, processing loans of less than £1 billion, according to West One Bridging.

By 2015, however, the annual lending figure jumped to over £3.5 billion – showing just how far this alternative finance industry has come in such a short space of time.

Why do landlords use bridging loans?

Bridging loans are most commonly used by landlords to make up a cash shortfall, allowing them to acquire a property.

They are also used for property refurbishment, accounting for 21% of bridging lending in the first quarter of this year, according to Bridging Trends data.

Bridging finance is often turned to for its speed. In fact, according to Bridging Trends – a publication by lender MTF and specialist finance brokers – mortgage delays were the most popular reason for accessing a bridging loan in the first quarter of the year, accounting for 42% of all lending.

According to Bridging Trends, the average completion time for a bridging loan application decreased by four days during Q1 2016 and for the third consecutive quarter, the average term of a bridging loan was 10 months.

Borrowers who go down the bridging route can apply for a closed loan with a fixed repayment date or an open loan which has no fixed repayment date.

Before granting finance, bridging lenders will require borrowers to provide evidence of a repayment and exit strategy.

How is bridging finance helping landlords?

Incoming changes to the buy-to-let mortgage industry – being enforced by the Bank of England's Prudential Regulation Authority – could make it harder for some landlords to get a buy-to-let mortgage and they may therefore have to turn to alternative finance.

The new rules will require buy-to-let lenders to carry out stricter 'stress tests' on prospective borrowers, making sure they have the funds to cover repayments in the event that interest rates increased to 5.5% for a full five years.

On top of this, the EU Mortgage Credit Directive – which has been in play since March – is aiming to bring all mortgage lending under one European framework, which could also see lending criteria tightened further.

As mentioned above, it's often the speed at which bridging finance can be processed which attracts landlords and investors.

Bridging has a much quicker completion rate than traditional lending, with some firms making funding available in as little as 24 hours.

The sector came into its own earlier this year as landlords tried to beat the stamp duty surcharge deadline on April 1.

Many investors were keen to push deals through before the deadline in order to avoid the additional 3% tax and so alternative finance was seen as a viable option to make sure transactions were completed on time.

Bridging Trends data suggests that this was certainly the case as annual gross bridging jumped by 56% in the first quarter of 2016.

Another common use for bridging loans is to finance property auction purchases due to the short time scale for completion once the gavel goes down.

In some cases, bridging can be the difference between a landlord missing out on a potentially lucrative investment opportunity or not.

Why landlords must think carefully and do their homework

Of course, bridging finance doesn't come without its risks and those thinking about using a bridging loan must incorporate the costs and an exit strategy into their plans.

It's key to remember that bridging finance is designed to be a short-term fix and so it should be considered as a means to progressing a project rather than financing one from the get-go.

Landlords who go down this route run the risk of getting into financial problems if they can't repay the loan and so the decision to use this type of finance shouldn't be taken lightly.

Bridging loans are expensive due to their high interest rates and set-up fees. They are therefore regarded by many as a last resort rather than a first port of call.

Anyone considering bridging finance should seek impartial financial advice before taking this step, and make sure any bridging loans are taken out with a firm regulated by the Financial Conduct Authority.

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