Prospective house buyers are turning to bridging loans in order to buy with cash and avoid getting stuck in a property chain, according to mortgage brokers.
House prices continue to grow despite the rising cost of living, with a shortage of properties coming to the market driving up competition.
Brokers are reporting a significant uptick in the number of prospective buyers requesting a short-term loan in order to cover the cost of their property, which they then pay off by selling their old home.
Chain reaction: Brokers are reporting an increase in enquiries for bridging loans, as buyers act to avoid getting caught in a property chain
This is despite the eye-watering interest rates, which range between 0.50 per cent and 1 per cent of the loan amount for each month that the money isn’t paid back.
Ashley Thomas, director at Magni Finance, said: ‘They pay a premium with higher rates and fees, but they feel it is worth it as there are a number of people offering on properties, with some vendors only accepting chain free buyers.’
In a busy market, the legal and mortgage process of buying a home can take longer to complete, 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 may then opt to refinance for a mortgage off the new property if they need to clear the bridging loan.
On average, Thomas says, the cost of a bridging loan varies from 0.50 per cent to 1 per cent per month.
Take the cost of a bridging loan for a £500,000 loan for a £1 million purchase price, at the top 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 arrangement fee for the loan costing £10,000. Add to this the reality that legal fees for this type of debt are usually higher than for standard mortgages – in this scenario probably around £1,000 more, plus a valuation fee of £1,000.
The monthly cost and arrangement fee is normally paid when the bridging loan is closed. The upfront cost would be would be the legal and valuation 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 loan. A £500,000 mortgage on a two-year fixed rate would charge around 3.24 per cent interest a year, working out at £1,352 per month.
There would likely be an arrangement fee of around £995 and no valuation fee. Legal fees would sit at standard rates.
Risk: Bridging loans can be an effective tool, but experts urge borrowers to exercise caution
Samuel Mather-Holgate, director at Mather & Murray Financial, says the team has seen a 200 per cent rise in bridging loans over the past year, driven by people stuck in a house buying chain.
‘Housing transactions are taking such a long time at the moment that more and more people are having to turn to bridging finance to secure their purchase, as they don’t want to lose it to more liquid buyers.
‘This can be very expensive, though, as set-up fees can be very high, as well as interest rates, especially if the security used has a low cover ratio.’
How do bridging loans affect your credit profile?
While some suggest that bridging loans may affect your ability to take out other products, Mather-Holgate isn’t so sure.
‘People tend to be 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 purchasing (assuming they are putting down a deposit) and their intended repayment vehicle is the sale of their current home.
‘That said, some people do also need a traditional mortgage to cover any shortfall. Most lenders will understand the situation, and a good credit score is much more important to lenders that the attendance of additional credit.’
For a £298,000 property – the current average property price in the UK, your monthly interest payments would be £2,291
He adds that if you have a 30 per cent deposit you would expect to pay approximately 0.75 per cent interest on a bridging loan per month. Compared to a traditional residential mortgage, you could be paying up to five times more with 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 a valuation fee of approximately £495.
Your monthly interest payments would be £2,291 and you could have a redemption fee of a few hundred pounds to pay when you want to clear it.
‘It is important to realise that bridging finance shouldn’t be compared to a traditional mortgage though, as the purpose is different. Bridging finance should be used as a short term facility to help bring a resolution to a temporary situation,’ Mather-Holgate says.
‘If your exit strategy is a standard mortgage then make sure you are confident you have a lender lined up for when you are ready,’ advises Michael Aldridge, director at Lucra Mortgages.
‘There is nothing wrong with using a bridge in the right circumstances, but ensure you are fully aware of all the associated costs and risks before you dive in.’
For those looking at taking out a bridging loan Mather-Holgate has some advice on what to look out for.
He advises borrowers to ensure they are fully aware of all of the charges and what the monthly repayments are going to be.
Be aware if the payments are fixed, or if they will go up if the Bank of England decides to raise its base rate again. Some predict it will hit 3 per cent by the end of the year.
Finally, he says, ensure it’s affordable. There is always uncertainly in chains, even when cash buyers are involved, and things can take longer than expected.
Best mortgage rates and how to find them
Mortgage rates have risen substantially as the Bank of England’s base rate has climbed rapidly.
If you are looking to buy your first home, move or remortgage, or are a buy-to-let landlord, it’s important to get good independent mortgage advice from a broker who can help you find the best deal.
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