Flexible refinance options are indispensable for property owners and investors in real estate. A large part of the property development sector is focused on the “Buy-Refurbish-Refinance” model, which is very popular amongst professional and private developers - however, this model has been heavily restricted in the wake of the mid-2000s financial crisis, and investors must now find ways to source finance that is both flexible and dependable.
Bridging finance is an exceptionally flexible tool which may be used in almost any scenario. Bridging loans may be put to use to “bridge the gap” when long-term financial solutions are not available; they are commonly used in the real estate sector as a short-term alternative to mortgages. Like mortgages, bridging loans are high-value loans typically secured on property, but they are a much faster and more adaptable form of loan. By using bridging finance to release equity from a building, property developers and landlords can quickly expand their portfolios without falling foul of the tight restrictions within the property market.
Bridging loans are a specialised form of finance, and before committing to this type of loan borrowers should make sure they fully understand the liabilities involved; anyone considering a bridging loan should consult a financial advisor before proceeding.
Bridging finance is needed in the real estate market because of the “6-month rule” that’s often applied to mortgages. Generally speaking, mortgage lenders are wary of offering a loan on a property that’s changed hands in the last 6 months, because some of these homes have been bought under-value. Buying a cheap house, refurbishing it and then either selling it or letting it out has been a full-time job for many individuals throughout the UK, and as a form of investment, it has been very popular over the years. However, unscrupulous buyers found a way to bend the rules of mortgage lenders for their own benefit, which led to over-exposure and the eventual collapse of the mortgage market.
Throughout the 90s and early 00s, the real estate market was only going up, year on year. This made property such a safe bet that many banks would happily agree to a 100% LTV loan, or a 90% buy-to-let mortgage; even if they were potentially exposed to default, the increased value of the property would more than compensate their initial loan. Banks could lend 100% of the purchase price for a £100,000 property, safe in the knowledge that if the borrower failed to repay they could sell the home at a profit easily enough.
Unscrupulous buyers saw an opportunity here, though, and exploited it to their advantage. A buyer might purchase a property under-value at an auction, and pay for it in cash; let’s say it cost them £100,000 to do so. The next day, they would call in a friendly valuation expert to value the property at a higher price, at £150,000, for example. They would then contact a mortgage provider and ask for a 90% LTV mortgage of £135,000, which the mortgage lender would duly provide; from their point of view, the house is worth £150,000 and the owner still retains 10% equity, so there’s no problem. However, it doesn’t take a genius to see that the sums don’t add up; the buyer has only put in £100,000, but has been given £135,000 by the bank. Even if they make no mortgage payments and lose the property (and their 10% equity of £15,000), they’re still making £20,000, so there’s no incentive whatsoever for them to make repayments on the loan - they’ve made a 20% return on investment without refurbishing or selling the property.
Because of these so-called “back to back” loans, mortgage lenders introduced their 6 month rule in the wake of the financial crisis to protect themselves from opportunistic refinancing. However, this has the unwanted effect of penalising legitimate buyers who want to quickly refurbish a property and sell it on - they won’t want to retain a house for 6 months (paying off a mortgage or short-term loan the entire time).
When buyers purchase a property to refurbish, they typically do so with a cash payment. This allows them to quickly close a purchase, which is necessary for many forced sales and auctions, but it means that buyers are heavily committed to a property. Instead of tying up their money in 100% of a property, many refurbishers would prefer to move on as quickly as possible by releasing their capital - this is typically achieved with a bridging loan.
For example, a buyer might have the opportunity to purchase a home for £65,000 in cash. They may then spend another £10,000 on renovations and end up with a property worth £85,000 - their goal is then to acquire a mortgage for the most part of the property’s value, which frees up capital to invest in other properties. The days of 90% buy-to-let loans are gone, but some lenders will still offer up to 75% LTV mortgages for these properties, which means the property owners could expect to release £63,750 from their investment (whilst still retaining 25% of equity in the property). However, they would have to wait 6 months to do so, which is often a death sentence in the real estate sector.
Instead, property owners can turn to bridging lending, where small and specialised teams of financial experts will work to create a bespoke lending solution to suit their client’s needs. Bridging finance is typically available much sooner than mortgages are, and bridging lenders will be able to provide much-needed capital for investment elsewhere. After securing a bridging loan, the property owners will typically seek to refinance once again with a mortgage provider as soon as possible, as this long-term solution is more affordable.
In the world of real estate, bridging finance is a crucial element for the success of property developers. The flexibility, speed and professional attitude of bridging financiers make it a powerful tool for property buyers and enables healthy expansion and growth across the industry.
A borrower that has gone past the scheduled repayment date of a bridging loan will know the answer to this question. Bridging loans are stereotypically sold as a dual rate product with a ‘discounted’ rate for a defined loan term of say 3,12 or even 24 months but if the loan then goes over the agreed term a ‘standard’ rate is usually applied. The standard rate will always be higher than the discounted figure, but they can often be substantially higher, sometimes doubled or indeed more. In such circumstances significant sums of additional interest can quickly accrue so a re-bridge can be a very useful option if a longer-term finance exit can’t be achieved.
It is unusual but unknown to find cases that have been re-bridged several times, with fees spiralling, equity being eaten away and still no clearly defined exit plan in place. These cases serve to underline the absolute importance of working directly and closely with experienced and ethical lenders. Good lenders will ensure positive borrower outcomes and that any re-bridge undertaken is a success.
Re-finance to a mortgage is one of the most common forms of exit strategy for bridging loans but work needs to be undertaken to make this happen. This work often starts before even the bridging loan has been agreed! Before agreeing to a short-term loan where the proposed exit is longer term funding the bridge lender will usually ask for proof that the application will fit the proposed mortgage lenders criteria. This is generally done by showing the bridging lender an agreement in principle (AIP) from the mortgage lender. Where this can’t be produced the bridging lender may accept sight of the mortgage lenders criteria on their website as proof that the client fits their terms. When an AIP can be obtained refinance to a longer -term mortgage can be a relatively straightforward exit route.
A finish and exit bridging loan provides funds to finish a development as part of the exit plan by paying off the existing development finance loan. Usually, if a development overruns slightly, this just allows the finishing touches to be completed and then for the provision of a proper marketing period whilst the property or properties are sold. Indeed, sometimes these loans can be used on completed developments to provide a decent marketing period or time for a letting record to be established. Thus, the gross development value (GDV) of the project can be maximised or the longer-term finance options enhanced.