Purpose of bridging loans
Bridging has long since moved on from its original purpose as either a vehicle for auction purchase or for people buying a home before selling their existing one. While these are, of course, still valid uses of a bridging loan, far more prolific now is its use by developers, landlords and property investors to buy, refurbish and/or develop property.
Many businesses also turned to short-term lenders to provide them with finance, driven by a lack of commercial lending by high street banks. Consequently, businesses of all types now use bridging as a fast source of additional capital, borrowing against existing property to fund business acquisition, expansion or take advantage of other opportunities.
The EY survey conducted in March this year, found 32% of bridging loans were now for business use with 29% for refurbishment. Interestingly, almost a fifth (17%) were used for mortgage delays.
So, far from being the lending of last resort, bridging is increasingly the first-choice option, meeting a very specific need.
What hasn’t changed is the need for bridging and short-term loans to be both fast and flexible. This still calls for individual underwriting with each case looked at on its specific merits with a turn-around time of days if not hours. Achieving this while carrying out thorough due diligence both on the property and the borrower is key to success.
Exit routes are king
Responsible lending for bridging lenders is not about a borrower’s ability to make monthly payments but more about exit routes.
Unlike a twenty-year repayment mortgage, paid off in instalments over the term, bridging loans have more in common with interest-only with the entire sum paid off at the end. Only, in the case of bridging, it is more usually a loan term of between three and 24 months. Therefore, the most fundamental issue affecting all bridging lenders is: what is the exit route and do I stand a realistic chance of having my funds returned within the set time period?
Key questions are: Is the borrower intending to move onto a longer-term loan or sell the property? Often a developer will buy a property in a state of disrepair, or one to adapt into flats or a house in multiple occupation (HMO), then take out a buy-to-let mortgage to let-out the completed properties.
Other property investors will plan to sell the property or properties once any work has been completed. Consequently, a bridging lender has to weigh up how realistic that sale or refinance will be both within the forecast time period and for the amount the borrower is expecting to achieve.
Bridging lenders therefore need to understand more than just their own sector when looking to grant a loan. Every prudent bridging lender will want to know up front, the likelihood of their borrower obtaining a longer-term mortgage or sale. They therefore also need to be in touch, both with the underwriting policies of mainstream lenders and the predicted movement of property prices in the region they are considering lending.
Of course, even over six months to a year, much can change and much can and will go wrong; it is therefore wise for the lender, the borrower and their broker to have contingency plans in place.
Default interest rates
The subject of default interest rates, is currently a hot topic. Default rates are a deterrent to help ensure borrowers pay their loan back on time. They can be charged from the day after a borrower reaches the end of their term if they haven’t paid back their loan.
Default rates can be anything from 0.6% to circa 5% per month, although it is hard to quantify exactly how much as few are declared publicly. As in all things, not all default interest is created equally however.
One factor is whether interest is charged daily or monthly. A low default interest rate does not save as much as it may appear if it is charged for a month on a loan paid back after just a few days.
The lower the LTV on a loan the more leeway a bridging lender will usually have. Because, typically, interest on a bridging loan is rolled up, on a higher LTV loan it can be unaffordable for a lender to extend a loan as this could lead to there being little equity left in the property.
It is this that makes almost any bridging loan over 75% LTV such a risk and why most prudent lenders will actively lend at lower LTVs unless they know the borrower well. Typically, it is the newer lenders who don’t appreciate this and move further up the curve to gain business and make a name.
Competition lowers rates
This brings me to the recent influx in competition. Both big names and small have entered the bridging arena over the past few years and while some remain, others have disappeared again, realising that bridging is a specialist area of lending that requires experience and skills to do it well.
There are still a number of new firms entering the sector however and the continual influx has done much to reduce rates. Rates that were easily 1.5% per month a few years back can now be 0.6%pm or even lower.
The Association of Mortgage Intermediaries (AMI) spoke recently of anecdotal evidence that arrears were rising at bridging firms; this can only be the case if the lender lends imprudently or does not carry out sensible due diligence. While no lending is risk free, established bridging lenders, focused on being here for the long term, will not take the level of risk that a newer firm trying to get established might.
The collapse of Lendy Finance recently raised questions over the role of this form of funding in bridging and its effect on the sector.
While P2P lenders do sometimes offer short-term lending, it is wrong to put these lenders in the same category as bridging when they often have very different lending practices, sometimes without the level of experience, due diligence and reserves that an established bridging lender will have.
All investment and lending types can be good when done well, but P2P needs sophisticated investors who understand that while rewards may be high it is because this is a riskier area of investment. Few investors will have any idea of the due diligence required to help secure returns when used as a bridging loan.