Using bridging finance at an auction
Auctions have proved a popular source for purchasing a property.
However, financing auction property purchases can be a challenge, particularly given timescales – and that is where bridging loan finance could be an option.
Andrew Turner, chief executive at Commercial Trust Limited, looks at how a bridging loan works when you are looking to buy at auction.
What is a bridging loan?
A bridging loan is a short-term form of lending and can usually be arranged much quicker than a buy to let mortgage, with turnaround times commonly around 28 days.
That said, one of the lenders we work with is able to pay out funds on the day of application (under the right circumstances).
Bridging loans can be used for a variety of reasons, including to:
- finance property purchase at auction;
- finance renovation work;
- purchase land for future development;
- purchase an uninhabitable property.
There are two bridging options: a service bridge where you make monthly payments; alternatively, the roll-up option allows you to defer payments and the interest accrued will roll-up and must be paid at the end of the loan agreement. This option allows you to reallocate funds to redevelop the property if that is one of your aims.
Usually, you are able to borrow up to 75% loan to value on a bridging loan.
If you are specifically looking to invest in a rental property at auction, there are time constraints that make buy to let mortgage financing problematic.
If you buy a property at auction, you will typically have to pay 10% of the property auction price on the day, and the outstanding sum within 28 days of the auction taking place. In some instances, you may have 56 days to pay in full, depending on the property and auction house rules.
Securing buy to let mortgage financing in such a short space of time is therefore likely to be unachievable.
Furthermore, if you are buying a property in disrepair, with the aim of carrying out improvements and later on either selling it or letting it out, then a typical buy to let mortgage lender will be unlikely to extend a mortgage.
With the much faster turnaround times and no requirement for the property to be habitable, a bridging loan is ideal to help you settle your purchase bill within the necessary timeframe and to buy to time to put in place an exit strategy.
The application process
Bridging loan rates vary, depending on factors such as the purpose of the loan and projected future rental income of the property (established by a valuer).
If the loan is to cover renovation work, then the lender might perceive heavier work (such as knocking down walls or building a conversion) to be a greater risk than, say, a kitchen renovation. Therefore, the rate might be higher.
As a rule of thumb, borrowing rates on a bridging loan will be higher than for a buy to let, because of the associated risk of this type of investment.
In most cases, the maximum term of the loan will be 12 to 18 months.
Much of the application process is similar to a buy to let mortgage application and the lender will want to know:
- the purpose of the loan;
- an idea of the property value – which will depend on the condition of the building;
- an estimate of anticipated rent (if you are looking to renovate and let the property);
- your intended exit strategy from the bridging loan (i.e. how you intend to pay off the loan in the agreed timescale).
With a bridging loan, it is essential to have an exit strategy in place for how you intend to pay off the borrowing.
If you are using bridging finance to buy a rental property at auction, then common exit strategies are:
- to sell the property once it has been renovated;
- to take out a buy to let or commercial mortgage (to fund the pay-off) once the property is in a habitable and/or lettable condition;
- if you are running a business, to pay off the debt through operating cash flows.
You must be able to demonstrate that you have a viable means to pay off the bridging loan within the agreed term and if not, you should not be recommended a bridging loan as an option.
In fact, be exceptionally wary of any financial professional who recommends a bridging loan to you where they have not arranged for you or agreed with you, your exit plan. To do this is very poor advice and may place you in a position of financial vulnerability.
Bridging finance is not for everyone and it is important to speak to a finance specialist to ensure it is the right option.
As with buy to let, the more research you put in at the planning stage, in terms of valuations, prospective rental income and establishing an exit strategy, the smoother the process might be to securing bridging finance.
Author; Andrew Turner
Telephone: 01603 896423
Date; 11th of March 2019