Potential home buyers are turning to bridge loans to buy with cash and avoid getting stuck in a real estate chain, according to mortgage brokers.
Home prices continue to rise despite the rising cost of living, with the shortage of properties coming onto the market fueling competition.
Brokers are reporting 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 pay off by selling their old home.
Chain reaction: Brokers report surge in bridging loan applications as buyers act to avoid getting caught in a real estate chain
This is despite the exorbitant interest rates, which vary between 0.50% and 1% of the loan amount for each month the money is not repaid.
Ashley Thomas, director of Magni Finance, said: “They are paying a premium with higher rates and fees but they think it is worth it as a number of people are offering properties with some sellers only accepting buyers without a chain.”
In a busy market, the legal and mortgage process of buying a home can take longer, so cash buyers have a distinct advantage.
Loans are normally structured on a short term basis with a maximum term of 12 months to allow the borrower to sell their current property. They can then choose to refinance a mortgage on the new property if they need to repay the bridge loan.
On average, says Thomas, the cost of a bridging loan ranges from 0.50% to 1% per month.
Take the cost of a bridge loan for a loan of £500,000 for a purchase price of £1m, at the higher end of the market.
The loan costs 0.57% per month (6.84% per annum), costing the borrower £2,850 per month. There will also be a 2% arrangement fee for the loan costing £10,000. Add to that the fact that the legal fees for this type of debt are usually higher than for standard mortgages – in this scenario probably around £1,000 more, plus a £1,000 appraisal fee.
The monthly cost and arrangement fee is normally paid when the bridge loan is closed. The initial cost would be would be legal and appraisal fees.
In total, even having the loan for a period of just one month would cost the buyer in our scenario almost £15,000 in interest and fees.
Compare these costs to arranging a typical mortgage. A £500,000 mortgage on a two-year fixed rate would charge around 3.24% interest per annum, or £1,352 per month.
There would probably be an arrangement fee of around £995 and no appraisal fee. Legal fees would be seated at standard rates.
Risk: Bridge loans can be an effective tool, but experts urge borrowers to tread carefully
Samuel Mather-Holgate, director of Mather & Murray Financial, says the team has seen a 200% increase in bridging loans over the past year, driven by people stuck in a house-buying chain.
“Real estate transactions are taking so long right now that more and more people are having to turn to bridge financing to secure their purchase, because they don’t want to lose it to more liquid buyers.
“It can be very expensive though, as set-up costs can be very high, as well as interest rates, especially if the security being used has a low hedge ratio.”
How do bridge loans affect your credit profile?
While some suggest bridge loans may affect your ability to take out other products, Mather-Holgate isn’t so sure.
“People tend to be asset-rich when they’re bridging,” he says. “They can use collateral in the home they’re selling, as well as the home they’re buying (assuming they put down a deposit) and their intended repayment vehicle is the sale of their current home.
“That said, some people also need a traditional mortgage to cover any shortfalls. Most lenders will understand the situation, and a good credit rating is far more important to lenders than the presence of additional credit.
For a £298,000 property – the current average UK house price, your monthly interest payments would be £2,291
He adds that if you have a 30% deposit, you expect to pay around 0.75% interest on a bridge loan per month. Compared to a traditional residential mortgage, you could pay up to five times more with a bridge loan.
For a £298,000 property – the current average UK property price – the arrangement fee would be £7,450 on top of the loan, and a valuation fee of around £495.
Your monthly interest payments would be £2,291 and you might have a redemption charge of a few hundred pounds to pay when you want to clear it.
“It is important to realize that bridge financing should not be compared to a traditional mortgage, as the purpose is different. Bridge financing should be used as a short-term facility to help resolve a temporary situation,” says Mather-Holgate.
“If your exit strategy is a standard mortgage, make sure you have an online lender when you’re ready,” advises Michael Aldridge, director of Lucra Mortgages.
“There’s nothing wrong with using a bridge under the right circumstances, but make sure you’re fully aware of all associated costs and risks before diving.”
For those considering taking out a bridging loan, Mather-Holgate has some tips on what to look for.
He advises borrowers to ensure they are fully aware of all fees and what the monthly repayments will be.
Know if the payments are fixed or if they will increase if the Bank of England decides to raise its base rate again. Some predict it will reach 3% by the end of the year.
Finally, he says, make sure it’s affordable. There is always uncertainty in the chains, even when cash buyers are involved, and things can take longer than expected.
The best mortgage rates and how to find them
Mortgage rates rose significantly as the Bank of England’s base rate climbed rapidly.
If you’re looking to buy your first home, relocate or mortgage, or are a rental property owner, it’s important to get good independent mortgage advice from a broker who can help you find the best deal.
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