Should you use a bridging loan to speed up buying a house, and what are the interest rates?

Potential homebuyers are turning to bridging loans to buy cash and avoid getting stuck in a real estate chain, mortgage brokers say.

Despite the rising cost of living, house prices continue to rise, while a shortage of housing on the market drives up competition.

Real estate agents report a significant increase in the number of potential buyers applying for a short-term loan to cover the cost of their property, which they then repay by selling their old home.

This is despite the dazzling interest rates, which range between 0.50 percent and 1 percent of the loan amount for each month the money is not repaid.

Ashley Thomas, director of Magni Finance, said: “They pay a premium with higher rates and fees, but they think it’s worth it because there are a number of people who list real estate, and some sellers only accept chain-free buyers.”

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

Loans are normally short-term structured with a maximum term of 12 months, allowing the borrower to sell their current property. They can then choose to refinance a mortgage on the new property if they need to settle the bridge loan.

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

Take the cost of a bridging loan for a £500,000 loan at a purchase price of £1 million, at the high end of the market.

The loan costs 0.57 per cent per month (6.84 per cent per annum), costing the borrower £2,850 per month. There will also be a 2 per cent settlement fee on the £10,000 loan. Add to that the reality that legal fees for this type of debt tend to be higher than for standard mortgages – probably around £1,000 more in this scenario, plus a £1,000 appraisal fee.

The monthly costs and brokerage costs are normally paid when the bridging loan is taken out. The upfront costs would be the legal and appraisal costs.

In total, even having a loan for just one month would cost the buyer nearly £15,000 in interest and fees in our scenario.

Compare these costs to arranging a typical mortgage loan. A £500,000 fixed-rate mortgage for two years would charge about 3.24 percent interest per annum, which works out to £1,352 per month.

There would probably be a settlement fee of around £995 and no appraisal fee. Legal fees would be at standard rates.

Samuel Mather-Holgate, director of Mather & Murray Financial, says the team has seen a 200 percent rise in bridging loans in the past year, driven by people trapped in a home-buying chain.

“Residential transactions are currently taking so long that more and more people have to take out bridge financing to secure their purchase because they don’t want to lose it to more liquid buyers.

‘That can be very expensive, because the start-up costs can be very high, as can the interest, especially if the security used has a low funding ratio.’

How do bridging loans affect your credit profile?

While some suggest that bridging loans can affect your ability to close other products, Mather-Holgate isn’t so sure.

“People are typically asset rich when they bridge,” he says. “They can use collateral in the house they are selling as well as in the house they are buying (assuming they make a down payment) and their intended means of repayment is the sale of their current home.

That said, some people also need a traditional mortgage to cover any shortfall. Most lenders will understand the situation, and a good credit score is far more important to lenders than the presence of extra credit.”

He adds that if you have a 30 percent down payment, you should pay about 0.75 percent interest on a bridging loan per month. Compared to a traditional home mortgage, you can pay up to five times more with a bridging loan.

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

Your monthly interest payments would be £2,291 and you could have a repayment charge of a few hundred pounds to pay when you want to settle it.

‘It is important to realize that bridging financing cannot be compared to a traditional mortgage, because the goal is different. Bridge financing should be used as a short-term facility to help find a temporary solution,” says Mather-Holgate.

“If your exit strategy is a default mortgage, make sure you have a lender for when you’re ready,” advises Michael Aldridge, director at Lucra Mortgages.

“There’s nothing wrong with using a bridge in the right conditions, but make sure you’re well aware of all the associated costs and risks before diving in.”

Mather-Holgate has tips for those looking for a bridging loan.

He advises borrowers to make sure they are fully aware of all charges and what the monthly repayments will be.

Keep in mind whether the payments are fixed or if they will rise if the Bank of England decides to raise its 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 supply chains, including cash buyers, and it can take longer than expected.