Let’s say that you’ve found this amazing home that you wish to buy. You’ve been browsing the market for quite some time, but a good offer never came out – until now. The problem is that you never actually managed to find a seller for your old home yet – in which case, you may use a bridging loan as a means to cover those costs.
More often than not, bridging loans are organised in a relatively quick manner – which works very well if you have an emergency. However, to ensure that you do not pay more than you need on the loan (or worse, you don’t get enough funds), you need to know how a bridging loan is calculated.
This guide should teach you everything you need to know about a bridging loan and how you may calculate it. This way, you will not lose your dream home simply because of a miscalculation.
How Does a Bridging Loan Work?
When setting a bridging loan, the calculation is based on the amount that you currently owe on your mortgage – along with the purchase price of the new home. This figure is referred to as “peak debt.” For instance, let’s say that you currently owe £200,000 on your mortgage and the new property that you are buying costs £500,000. In this case, your peak debt here would be £700,000.
Once the peak number has been figured out, your lender will then subtract the price at which your home is likely to be sold. At this point, a buffer is also built in so that the fact that it’s sold at the lowest price is also taken into account. The remaining sum will be your bridging loan.
A bridging loan works only on interest, meaning that the only thing you owe is the interest that has been charged for your current balance. The lender will capitalize on this interest, allowing you to pay upon the time you sell your current property. Once you do, the bridging loan will be turned into a regular loan.
When calculating your bridging loan, you also need to keep in mind there are two of them going around: the closed bridging loan and the open bridging loan. Each may have different bridging loan interest rates, in which case you will have to understand what they do – and how they will affect you. Here is what you may choose from:
- Open Bridging Loans: Open bridging loans are taken out by buyers that want to sell their old home but have not found a buyer yet. Due to the uncertainly of the background, lenders are either reluctant to give this type of loan – or they do so at a very high interest rate. They are also adamant that you have significant equity along with an exit strategy put into place.
- Closed Bridging Loans: Unlike open bridging loans where everything remains uncertain, closed bridging loans are more secure. With this type of loan, you already have a buyer, and you know at exactly what time your house will be sold. The exchange on your existing property sale has already been made, which means that you may opt for this type of loan.
The cost will not only depend on the type of bridging loan that you choose but also on your credit score. Obviously, people with bad credit will have a more difficult time finding a more affordable bridging loan.
Bridging Loan Timeframe
Bridging loans are also calculated based on their timeframe, which begs the question: how long do bridging loans last? In most cases, a bridging loan is given for a period going to up to 6 months, but some lenders will offer as much as 12 months. This is why you have to do your research – because the longer the period, the more volatile the interest rate may be.
Most people get a bridging loan to purchase a pre-existing dwelling place. However, some take the bridging loan in order to purchase land and build a new house. You simply need to find a lender that is willing to give you this loan.
Bear in mind that in order to get a new property, you will have to provide a 20% deposit – mainly because the bridging loan is not covered by the LMI (Lenders Mortgage Insurance). Those of you that do not have the funds readily available might want to consider a deposit bond as well – since quite often, they have proven to be a very good alternative.
This deposit bond acts as a substitute for cash, where the borrower guarantees they will pay the amount in full by the date set. Bonds may be issued for as long as 48 months – but bear in mind that the shorter the period, the less it will cost you in the long run.
Additional Fees to Consider
When calculating a bridging loan, you also need to keep in mind that there are several other fees you might want to consider. Like pretty much any other loan, a bridging loan will also be subjected to interest. Looking at the features, one would say that it is similar to a personal line of credit or an open mortgage.
That being said, it is true that the bridging loan interest rate is generally higher in comparison to your average mortgage rate. However, what makes up for it is the fact that you will only be charged for a short period – before the equity from your previous home becomes available to pay off the loan.
Aside from the standard interest rate, you also need to consider the fact that the lender might charge you an administration fee – generally going from £150 to £300. This depends entirely on the lender, as each of them has its own fares. Here are some examples of fees, along with their average prices:
- Facility fee: 1%
- Valuation fee: £250
- Admin fee: £295
- Bank transfer fee: £35
- Legal fee: £450
Moreover, if you need a bigger loan for a more expensive house (for example, over £200,000), the lender is entitled to register a lien on your property. This can also happen if the loan goes over an extended period (more than 6 months). To take this lien down, you may wish to opt for the services of a real estate lawyer.
The Interest Rates of a Bridging Loan
When it comes to the interest rates of a bridging loan, you should know that these are variable. Since these loans are quite expensive, the calculations are generally done on a monthly basis rather than on a yearly basis. That being said, the interest rates could go anywhere from 0.4% to 2%.
Since it is just a way of “tiding you over,” a bridging loan is not calculated over a long period of time. So, instead of charging for APR (annual percentage rate), they only charge monthly rates. This means that even a slight modification in the interest rate can be a great impact on the full cost of your bridging loan.
That being said, bridging loan interest rates are not only calculated for monthly payments. Here are 3 ways in which you may have to pay them:
- Monthly Payments: with these monthly payments, you pay the interest every month – in which case, it will not be added to the overall bridging finances.
- Retained Payments: The interest is borrowed for a specific amount of time, and at the end of the bridging loan, you will have to pay it back entirely.
- Rolled Up or Deferred Payments: All your interest rate is to be paid by the time your bridge loan comes to an end, with no other monthly interest payments.
There are some lenders that allow you to combine these options when calculating your bridging loans. For instance, if you have a one-year bridging loan, you may go for retained interest for the first half, and then switch to monthly payments in the second half.
Bear in mind that like with any other loan, the interest rates can be fixed or variable. With a fixed interest rate, you will pay the same sum over a fixed course of time. However, things may be more difficult to calculate with a variable rate, as it usually changes with the base rate of the Bank of England.
Using a Bridging Loan Calculator
In most cases, when you calculate a bridging loan, you might want to use a special calculator for this. These calculators represent an efficient tool that most lenders use when they are creating a quote for you. They might also be used to figure out exactly how much interest they need to charge – and they might also prove efficient to borrowers, as they can give an average on how much they will have to pay up.
To use these calculators, you will have to introduce information such as the net amount, the length of the term, along with the other details regarding your deposits. The result won’t always include the other fees, which the lender will add thereafter.
Each lender will use a different calculator, something which may result in different returns. You may go for a total cost of bridging loan calculator, interest calculator or rates calculator. However, while it might not be a bad idea to use these calculators yourself (it will give you a decent average), you might want to also discuss with a bridging finance expert.
Examples of Standard Bridging Loans
There are various bridging loan examples that you may go for, each calculated based on a number of variables. Some may include certain variables – others may be exempt from them. These loans may also be calculated differently from lender to lender, depending on their offers.
Let’s say that you get a £100,000 bridging loan with a 0.65% interest rate, and you wish to take it over the timespan of one month. In this case, the total interest rate would be £657 – and if you add the fees (mentioned above) that reach £2,030, the total sum that you will have to repay is £102,687.
This will change over the course of 6 months. For the same sum, the interest rate will be £3,942 – so, if you add the £2,030 fees, the total amount that you will have to pay is £105,972. The more it takes for you to pay this loan, the more it adds up to the calculations. The same thing applies if you go for a loan with a higher interest rate.
The Bottom Line
As you can see, calculating a bridging loan involves quite a number of factors that you will have to consider. From the interest rate to the fees and the other variables, each loan will have a different price range – which is why you should always double-check your options to make sure you make the best decision.
Rachael Villam is a certified crypto zealot, finance writer, and a steady swing trader. She is passionate about blockchain’s capacity to transform cities, commerce, and the entire banking system as we know it. Dune bashing, camping, and working with kids are his non-crypto interests.