Potential homebuyers turn to bridge loans to buy with cash and avoid getting locked in a chain of ownership, according to mortgage brokers.
House prices continue to rise despite the rising cost of living, with a dearth of properties coming on the market fueling competition.
Brokers are reporting a significant increase in the number of prospective buyers applying for a short-term loan to cover the cost of their property, which they then pay by selling their old home.
Chain Reaction: Brokers report an increase in bridging loan inquiries as buyers act to avoid getting caught up in a real estate chain
This is despite eye-popping interest rates, which range from 0.50 percent to 1 percent of the loan amount for every month the money isn’t paid back.
Ashley Thomas, director of Magni Finance, said: “They pay a premium with higher rates and fees, but they feel it’s worth it as there are multiple people listing properties, and some providers only accept non-chain buyers.”
In a busy market, the legal and mortgage process to buy a home can take longer to complete, so cash buyers have a distinct advantage.
Loans are typically 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 pay off the bridging 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 for a £1 million purchase price, at the higher end of the market.
The loan costs 0.57 per cent per month (6.84 per cent per year), which costs the borrower £2,850 per month. There will also be a 2 per cent arrangement fee for the loan that costs £10,000. Add to this the reality that the legal fees for this type of debt are often higher than for standard mortgages; in this scenario probably around £1,000 more, plus a £1,000 appraisal fee.
The monthly cost and origination fee are usually paid when the bridging loan is closed. The initial cost would be 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 those of a typical home loan. A £500,000 mortgage with a two-year fixed rate would charge around 3.24 per cent interest per annum, which equates to £1,352 a month.
There is likely to be an arrangement fee of around £995 and no appraisal fee. Legal fees would sit at standard rates.
Risk: Bridge loans can be an effective tool, but experts urge borrowers to be careful
Samuel Mather-Holgate, a director at Mather & Murray Financial, says the team has seen a 200 percent increase in bridge loans over the past year, driven by people caught up in a home-buying chain.
“Housing transactions are taking so long right now that more and more people are turning to bridge financing to secure their purchase, as they don’t want to lose it to more liquid buyers.
“However, this can be very expensive, as set-up fees can be very high, as well as interest rates, especially if the security used has a low coverage ratio.”
How do bridge loans affect your credit profile?
While some suggest bridging loans may affect your ability to purchase other products, Mather-Holgate isn’t so sure.
“People tend to be asset rich when they go online,” he says. ‘They can use collateral on the home they’re selling as well as the home they’re buying (assuming they’re putting down a deposit) and their intended payment vehicle is the sale of their current home.
‘That being said, some people also need a traditional mortgage to cover any shortfalls. Most lenders will understand the situation, and a good credit score is far more important to lenders than additional credit assistance.
For a property of £298,000, the current average UK property price, your monthly interest payments would be £2,291
He adds that if you have a 30 percent deposit, you would expect to pay about 0.75 percent interest on a bridging loan per month. Compared to a traditional residential mortgage, you could be paying up to five times more with a bridge loan.
For a £298,000 property, the current average UK property price, the origination 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 might have to pay a surrender fee of a few hundred pounds when you want to pay it off.
“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, then make sure you have a lender ready for you when you’re ready,” advises Michael Aldridge, director of Lucra Mortgages.
“There’s nothing wrong with using a bridge in the right circumstances, but make sure you’re aware of all the associated costs and risks before you dive in.”
For those looking to get a bridging loan, Mather-Holgate has some advice on what to look for.
He advises borrowers to make sure they are aware of all fees and what the monthly payments will be.
Consider whether the payments are fixed or will increase 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 on chains, even when it comes to cash buyers, and things can take longer than expected.
The best mortgage rates and how to find them
Mortgage rates have risen substantially as the Bank of England base rate has risen rapidly.
If you’re thinking about buying your first home, moving or remortgaging, 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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Use the tool at the link below to compare the best deals, taking both fees and rates into account. You can also start an online application on your own time and save it as you go.
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