The term “bridging finance” is frequently misused including by many in the industry, not least brokers who only arrange it very occasionally. It would be more readily understood and hold fewer fears for both client and broker if the term changed to “short term finance”. This term is more self-explanatory and truly reveals all the circumstances that it can cover. Essentially it is a short term means to an end and fills the gap between a sale or the availability of conventional longer-term finance. Below are few examples how bridging can help.
Sale and purchase chains
The most straightforward circumstance where bridging is necessary is when the purchase of one property is dependent on the sale of another property, and when there has been a delay in the latter. There are two reasons why a client may not be able to proceed without the help of a short-term loan
- If there is a mortgage on the house being sold and there will be a new mortgage on the house being bought, it maybe that either a client cannot afford both mortgages at the same time or the mortgage lenders will say that its unaffordable
- The more frequent reason is that the sale of the first house usually generates the deposit for the house being purchased. Obviously, this isn’t going to happen unless the sale and purchase are simultaneous.
In this circumstance the bridging lender will want to see evidence of the purchase proceeding, albeit not concluded, and evidence of the sale being at an advanced stage, again albeit not concluded. What the bridging lender will do is to take the security of one or both houses for his loan and effectively lend 100% of the purchase price of the new house. Obviously, this is subject to there being enough equity in the houses to satisfy the lender’s conditions.
Building and Development finance
Normally a builder doesn’t have enough money to buy the land and to complete the building. Once the house is finished, the builder is relying on the option either to sell or to find long-term finance. The lenders who are in the market to provide long-term loans need to have a fully completed house on which to lend. It is the type of asset that they are familiar with and “understand”; they are not in the market of providing loans on green fields or half-built houses. Given that the time taken to buy, and to build is usually less than two years, some kind of short-term loan is needed to cover that period.
The availability of short-term finance is not restricted to medium or large-scale companies but is available to the private individual with a small building project or even a conversion/refurbishment project. The main difference between the professional developer and the non-professional, is which lenders are in the market and what the interest rate charged will be. So, for example, it is currently the case that the recognised High St banks lend to the larger projects from larger companies and less well-known specialist companies lend to smaller schemes
In nearly every circumstance where bridging finance is needed, the borrowers cannot afford to make monthly payments. This is especially true of builders who are expecting to make their profits out of a sale and whose cash flow is very restricted during the build. Although the option is offered to make regular interest payments, the lenders are happy to offer that interest payments are added to the loan and settled when the bridging finance is paid back.
It is important to note that when a bridge loan is being used for property development, usually you will only need money in tranches as your project proceeds. The lender only charges you interest for money drawn down by you, and for the period that it is drawn down. If you have asked for a larger facility for either or both amount and time (see below on Safety Margins), and you never need to use it, then you are not charged for it.
Safety Margins in Development Bridges
It is particularly important to give this subject some thought. There are two points of view to consider;
- The borrower needs to make sure that they have enough money to achieve their objective
- What does the lender think if the borrower doesn’t get it right?
Let’s consider the second point first. What would you think if you were a lender and the borrower came to you asking for more money or asking for you to extend the time? You would think – “what’s gone wrong?”. Not only would you want to know why, in great detail, but if you weren’t happy with the answers, you may not want to lend any more and you might want your money back as soon as possible. And if that meant taking over the site and the project, it may be something that you needed to do. If you are the borrower, you could not guarantee that a lender would not take that standpoint.
So now addressing the first consideration. As the borrower you will want to have safety margins for your own peace of mind. A 10% or 15% contingency on costs is usually fine. When it comes to sale or refinance to a long-term loan, you must take account of how long this takes. For example, someone buying a house that you have built may agree the price very quickly but by the time a mortgage is organised, and solicitors have done their work, it can easily take 3 or 4 months or more. So, it is really important that you take all these factors into account when asking the lender. In fact, if you list your reasons for the extended term or increased amount, the lender will see that as impressively prudent and organised.
For any “normal” loan or mortgage, the affordability to a borrower to pay the monthly interest is the primary condition for a lender. In bridging finance, no monthly payment is required, so affordability and thus the borrower’s income does not come into the reckoning. Because the lender is adding the interest to the loan, it is the loan-to-value of the property at the end of the deal that is vital. The lender will look at your request then calculate what the potential interest could be if you drew down the full amount requested at outset and didn’t repay it until the very end of the requested term. This represents in effect the maximum potential facility that might be needed, and this has to fit the lender’s loan-to-value criteria.
Simple residential, “chain-breaking” bridges, do not really need the borrower to meet any personal conditions, because it is all based on the value of the property/properties.
In the case of property development bridges, there is far more to be taken into account
- Does the project have full planning permission; “outline planning permission” is insufficient
- Does the developer have appropriate experience for the project?
- If not, what professionals is the developer employing to supervise the project and what is their experience and qualifications?
- What is the experience of the builder actually doing the work?
The Bridging Market
Prior to “The Crash” in 2008, there were not many bridging lenders in the market. The need for bridges and the types required were still there but they were provided by a smaller number of specialist lenders. Since “The Crash” and the collapse in interest rates more of the merchant banks have turned to other ways to make money and the consequence was and is a proliferation of new bridging lenders. This is excellent news for borrowers because not only is there competition in the market in respect of interest rates, but the range of circumstances accommodated is wider. And that is continuing to happen today with interest rates dropping in the face of even more competition. What really hasn’t changed is the core numerical underwriting rationale.
The Next Move
Do not be frightened by the term “bridging finance”. Whereas most people will come across residential mortgages at least once in their life, very few people will have the need for a bridge, unless they are regular property developers. It is a reasonable consequence of that lack of familiarity, that people are reluctant even to enquire. Don’t be!
Do your research and only contact bridging loan brokers who are experienced in bridging loans. Their knowledge will be invaluable.
Norman Phillips is a Director at Drake Mortgages