Bridge loan financing: what is it and how does it work?

Wondering what a bridging loan is?

Whether you’re considering renovating an existing property, looking to buy at auction, or simply need to ‘bridge the gap’ whilst waiting to sell your own home, a bridge loan could be the answer. 

In the first quarter of 2023, over £278m in bridging loans was lent, proving it to be a popular and now well-established finance option.

Bridge loans are commonly used on investment purchases, with 24% of all bridging loans used for this purpose. 

Loans of this type can allow some breathing space when short-term cash is needed and can be vital in securing a property at auction.

What is a bridging loan? 

A bridging loan (or bridge loan) is a form of finance that can be used to maintain momentum in a purchase or investment when personal funds are temporarily unavailable.

It does this by ‘bridging the gap’ between the amount of money currently available and the total amount required. 

This usually involves relatively large sums of money being borrowed for short periods of time. 

How does a bridge loan work? 

A bridging loan is a form of short-term finance to help you plug a temporary finance gap.

It works by being either a first or second charge on your property.

A first charge means that the bridging loan is the main loan on your property; for example, if you own your home outright and are using the bridging loan to complete a renovation, the bridging loan would be a first charge on your home.

If you already have a mortgage, this will be the first charge and your bridging loan will be a second charge – the order in which creditors would be repaid should you fail to keep up repayments. 

Types of bridging loan 

A bridging loan can be taken out in two main options: open and closed loans.

It is important to understand the type of bridge loan that is required for your own circumstances and to fully understand how the loan works.

Open bridging loans

An open bridge loan allows you to borrow money with no fixed repayment date agreed with your lender.

However, although the exact date isn’t fixed, you will usually be expected to pay back the full amount within one year. 

As with any form of finance, the less certainty the lender has regarding repayment, the more important the evidence that you provide to underscore your ability and intention to repay funds.

The lender will want to know exactly how you plan to repay your bridge loan, for example through the release of home equity or via a more permanent solution such as a mortgage. 

ALWAYS ensure you have a strategy to repay your loan to avoid damage to your credit rating (or worse). 

Closed bridging loans

A closed bridge loan is more straight forward in that a final repayment date is agreed in advance by both parties.

This could be the date of exchange for a property purchase for example. 

With a closed bridge loan, the lender will still want to see evidence of how you plan to repay the amount borrowed. 

What can I use a bridge loan for? 

A bridge loan can be used to finance the purchase or renovation of residential, business or commercial property and is an alternative to taking out a second mortgage or re-mortgaging a property. 

As previously mentioned, a bridge loan can be ideal for purchasing a property through auction.

You may not have the cash released from previous or other investments and a bridging loan can help until you do.  

Likewise for beating the curse of a house-buying chain.

A bridge loan allows you to proceed with the purchase of a new property without having to wait until all parties in the chain have exchanged contracts.  

Perhaps you are building your dream home from scratch? A bridge loan can be used to purchase the land, pay fees and for building materials until such time as your mortgage funds come through. 

How much do bridge loans cost? 

When considering the cost of your bridge loan remember to take into account the related costs in the form of broker fees, valuation fees, exit fees and solicitor fees.

You may also have to pay an arrangement fee to the lender. 

A valuation fee will apply if you are securing the loan against a property – the lender needs to be sure that the loan to value (LTV) is appropriate and will price their risk accordingly.

Some lenders will charge a fee when your bridging loan repayment period comes to an end.

This is to cover administration fees like removing their name from the house deeds once repayment is complete. Which currently estimates monthly fees being between 0.5% and 1.5%. 

As with most forms of finance, the interest rate applicable to the loan will be dependent on a number of factors including earnings, level of savings, the agreed repayment term and the amount borrowed.

All of these will impact your interest rate and the overall cost of the loan. 

What are the interest rates for a bridge loan? 

Like other loans, lenders offer bridging loans with either fixed or variable interest rates.

A fixed rate will provide more security, with a set rate for a specified term.

This will help you with your budgeting and personal finance management as you will know the exact monthly cost of your bridging loan. 

A variable rate may offer a lower initial monthly cost, however, this rate will be affected by external economic and fiscal influences outside of your control.

For example, if inflation increases, the Bank of England (in the UK) may choose to counter this by increasing the base rate for borrowing money.

If this base interest rate rises (or falls) then variable bridge loans may rise or fall in relation to it. With the base rate currently at 0.5% in the UK – the only way is up. 

Which currently estimates bridge loan interest rates being between 6.1% and 19.6% - far higher than mortgage rates. 

However, this factors in the flexibility and short-term nature of bridge loans. 

Bridge loan companies and lenders 

There are numerous companies offering bridging loans and, with the large sums of money often involved in bridging loans, it’s important to choose the best fitting lender for your requirements.

Always ensure that any bridge financing company is a member of the Financial Conduct Authority (FCA).

This will ensure that any issues or complaints are managed in line with FCA guidelines. 

Bridge loans for bad credit 

Applying for bridge loans for bad credit is slightly more difficult but is not impossible.

Your credit rating may affect whether you are accepted for a bridge loan, or it may simply influence the interest rate or fees that you pay.

There are a number of loan companies and lenders that specialise in bridge loans for bad credit. 

How to apply for a bridge loan 

Now you know all there is to know about bridge loans, you may be wondering how to apply. 

Unbiased has 27,000 independent financial professionals across the country who can support you with your application.

Let us match you to your perfect financial adviser.