Should a bridging loan be used to speed up a home purchase and what are the interest rates?

Prospective homebuyers are turning to temporary loans in order to buy with cash and avoid being caught in a chain of properties, according to mortgage brokers.

Home prices continue to grow despite the rising cost of living, with fewer properties coming to the market resulting in increased competition.

Realtors have reported a significant increase in potential buyers asking for a short-term loan in order to cover the cost of their property, which they then pay off by selling their old home.

This is despite the amazing interest rates, which range from 0.50 percent to 1 percent of the loan amount for each month the money is not repaid.

“They pay a premium with higher rates and fees, but feel it’s worth it because there are a number of people offering properties, with some sellers only accepting chain free buyers,” said Ashley Thomas, director of Magni Finance.

In a crowded market, the legal and mortgage process of buying a home can take longer to complete, so cash buyers have a distinct advantage.

Loans are usually structured on a short term basis for a maximum period of 12 months to allow the borrower to sell their existing property. They may then choose to refinance the mortgage from the new property if they need to settle the bridging loan.

On average, says Thomas, the cost of a bridging loan ranges from 0.50 percent to 1 percent per month.

Take the cost of a £500,000 loan bridging loan to a £1m purchase price, at the higher end of the market.

The loan costs 0.57 per cent per month (6.84 per cent per annum), and costs the borrower £2,850 per month. There will also be an arrangement fee of 2 per cent for the £10,000 loan. Add to this the fact that legal fees for this type of debt are usually higher than standard mortgages – in this scenario it’s probably around £1,000 more, plus a £1,000 appraisal fee.

The monthly cost and arrangement fee is usually payable at closing of the bridging loan. The initial cost will be the legal fees and appraisal fees.

Altogether, even taking out the loan for just one month would cost the buyer in our scenario approximately £15,000 in interest and fees.

Compare these costs to a typical mortgage loan arrangement. A £500,000 two-year fixed rate mortgage would charge around 3.24 per cent interest per annum, for £1,352 per month.

There is potentially an arrangement fee of around £995 and no assessment fee. Legal fees will be at standard rates.

Samuel Mather-Holgate, director of Mather & Murray Financial, says the team has seen a 200 per cent increase in temporary loans over the past year, driven by people stuck in the chain of buying a home.

Housing transactions are taking a long time right now as more and more people are having to resort to bridging financing to secure their purchase, as they don’t want to lose out to more liquid buyers.

“This can be very expensive, although setup fees can be very high, as well as interest rates, especially if the security used has a low coverage ratio.”

How do temporary loans affect your credit profile?

While some suggest that temporary loans may affect your ability to obtain other products, Mather-Holgate isn’t so sure.

“People tend to be rich when they bridge,” he says. They can use collateral on the home they are selling, as well as on the home they are buying (assuming they put down a deposit) and the intended payment vehicle is the sale of their existing home.

However, some people also need a conventional mortgage to cover any shortfall. Most lenders will understand the situation, and a good credit score is far more important to lenders than attending extra credit.

He adds that if you have a 30 percent deposit, you can expect to pay about 0.75 percent interest on a bridging loan per month. Compared to a traditional residential mortgage, you could be paying up to five times as much on a bridging loan.

For a £298,000 property – the current average property price in the UK – the arrangement fee would be £7,450 on top of the loan, and an appraisal fee of around £495.

The monthly interest payments will be £2,291 and you may have a recovery fee of a few hundred pounds to pay when you want to settle.

It is important to realize that bridging financing should not be compared to a conventional mortgage, as the purpose is different. ‘Bridge financing should be used as a short-term facility to help bring about a solution to a temporary situation,’ says Mather Holgate.

“If your exit strategy is a standard mortgage, make sure you’re confident you have a lender ready when you are,” advises Michael Aldridge, Principal at Lucra Mortgages.

“There is nothing wrong with using the bridge in the right circumstances, but make sure you are fully aware of all associated costs and risks before diving in.”

For those looking to secure a bridging loan, Mather Holgate has some advice on what to look for.

Borrowers are advised to make sure they are fully aware of all fees and what the monthly payments will be.

Be aware if the payments are holding steady, or if they will rise if the Bank of England decides to raise the base rate again. Some predict it will reach 3 percent by the end of the year.

Finally, he says, make sure it’s affordable. There is always uncertainty in chains, even when it comes to cash buyers, and things can take longer than expected.