Bridging Loans: What You Need to Know

Before applying for a bridging loan, it’s essential to understand the key financial terms, costs, and fees involved. These details play a crucial role in your decision-making process.

Your lender will typically outline these terms in the decision in principle or the illustration provided before your application begins, helping you make informed financial decisions.

The top 12 key financial terms for Bridging Loans

Mortgage Decision in Principle:

A Decision in Principle (DIP) serves as an initial estimate of the amount that a Bridging or Mortgage lender might be willing to lend you or your limited company.

A Decision in Principle (DIP), also known as an Agreement in Principle (AIP) or Mortgage in Principle (MIP), is an initial assessment conducted by a lender to ascertain the likelihood of offering you a mortgage.

In order to obtain a DIP you may be asked to provide basic financial information, including income, expenses, and credit history. The lender then often conducts a soft credit check to evaluate your creditworthiness and affordability.

While a DIP does not guarantee a mortgage offer, it gives an estimate of the amount you might be able to borrow. The mortgage illustration can be submitted to estate agents, accountants and other professionals refinance exit is feasible, ensuring eventual repayment of the loan. If you'd like to discuss your options or obtain a DIP, feel free to contact us today.

There are three main quote stages:

  1. Illustration: This quote is indicative and provided by the lender based on your initial submitted information. It often includes assumptions and may prompt additional questions about your circumstances.

  2. Formal DIP: This quote is underwritten and based on your submitted information, with many questions and assumptions already confirmed as acceptable. At this stage, a hard credit check is often conducted, and you may have signed an authorization form indicating your intention to proceed further. However, formal DIPs are still subject to legal and valuation processes, as well as final underwriting checks.

  3. Finalised DIP: Once your loan has been finalised or completed, you'll receive a finalised DIP outlining the agreed-upon terms with the lender.

Loan To Value (LTV)

The Loan-to-Value (LTV) ratio is a key financial metric used by lenders to evaluate the risk associated with a loan in relation to the appraised value or purchase price of a property. This is the percentage amount the lender is willing to lend you based on your property value, therefore if your valuation basis restricts your property value, your loan amount will also be lower.

The loan or the LTV ratio is calculated as follows:

LTV=(Loan Amount / Appraised Value)×100

or

Loan Amount = LTV (%) × Appraised Value

Lenders utilise the LTV ratio to gauge the level of risk involved in lending money against the underlying collateral. Generally, a lower LTV ratio signifies less risk to the lender, as it provides more cushion in the event of borrower default and property sale. Lower LTV ratios may also result in more advantageous loan terms, including lower interest rates and longer loan durations.

It is important to note that for a bridging loan, the loan-to-value ratio pertains to the gross loan amount. In broad terms, this is the amount to be repaid by the borrower (excluding fees) and not the amount received by the borrower.

Valuation Basis & 180 Day Valuation Basis

The valuation basis represents the underlying assumptions utilised in determining the property value, which therefore affects your Loan to Value. Bridging lenders commonly assess properties against the Market Value and the 180-day value.

Why is this important? This is important because 180-day values are typically 5% to 15% lower than the Open Market Value (OMV). Meaning that the valuation basis can drastically affect the loan-to-value (LTV) ratio a lender offers. It's a subtle tactic some lenders use to limit their loan offering, even while promoting higher LTVs. Understanding this distinction can help you avoid potential shortfalls and ensure you're getting the deal you expect.

The difference between the OMV and 180-day is generally determined by factors such as property type, condition, location, and prevailing market demand, which could extend the selling duration beyond 180 days, thereby influencing the final valuation.

For the average property in the UK, where the typical time from marketing to completion spans around 6 months (equivalent to 180 days), there's usually no significant difference between the 180-day valuation and the OMV.

Tip: When exploring bridging loans, it's essential to understand how different lenders handle valuations and their overall reputation. Partnering with an experienced broker who understands your unique circumstances will ensure your deal is placed with a lender that perfectly aligns with your needs.

Commercial Bridging Loans often have significantly shorter valuation basis like ‘90-days’ which may yield more adverse valuation outcomes. 90-day valuations are infrequently used for residential bridging loans as but they are frequently used for commercial bridging loans. The 90-day typically discounts around 10-15% for residential and between 15-25% for commercial.

Tip: It's crucial to recognise that if a broker advises you to inflate the property value in your loan application, it poses a significant risk. This strategy increases the likelihood of encountering difficulties in refinancing the loan or incurring abortive costs if the property is subsequently down valued, leading to the loan falling through.

If you already have a valuation from another lender, we have lenders on our panel that will reassign, update or readdress the report or rely on it with no valuation.

Unsure about valuations - apply for our No Valuation product here.

Gross loan

The gross loan of a Bridging Loan is the amount is gross amount being borrowed by the borrower and is calculated by multiplying the loan-to-value ratio by the property value.

Gross Loan = Appraised Value × Loan to value (LTV %)

In retained interest bridging loans, this figure represents the loan amount before any deductions for fees, interest, or related expenses.

All interest and fees are computed based on this gross loan amount. For instance, if the interest rate is 1% per month, it equates to 1% per month of the gross loan amount monthly not the amount.

It is important to note that the gross loan amount for a retained bridging loan is not the amount the borrower receives - read retained interest below.

Serviced Interest Bridging Loan

Serviced interest, unlike retained interest, is less common in the bridging finance sector. With serviced interest, the lender calculates the monthly interest on the loan amount and collects it from the borrower, typically through direct debit from their account monthly. While the interest for a serviced loan is still calculated on the gross loan amount, the advance is notably higher compared to a retained loan because the interest is not being retained so the gross is similar to the net loan.

In a serviced loan, or Serviced Bridging Loan payments are made periodically through instalments over a designated term of the loan. These payments contribute to either the principal balance of the loan and the interest accrued on that balance (repayment loan), or solely to the interest (interest only), depending on the terms of the loan.

In a serviced bridging finance scenario, the calculation for the net loan amount involves deducting the arrangement fee and any additional fees from the gross loan.

Gross Loan − Arrangement Fee − Additional Fees = Net Loan

Serviced bridging finance tends to be more expensive due to the increased risk taken on by the lender, leading to more conservative Loan-to-Value ratios to mitigate potential default risks.

Furthermore, serviced bridging entails stringent underwriting criteria, with lenders scrutinising borrowers' credit history, property income, occupation, property expertise, and wealth to approve loans. This results in a greater need for supporting documentation and longer processing times for applications.

From the borrower's perspective, serviced interest represents a higher risk as they must make monthly payments while arranging repayment of the loan. If the property fails to generate income exceeding the monthly payment, the borrower is personally responsible for servicing the loan, which could affect their creditworthiness.

Semi-serviced arrangements are also common in bridging finance, where a portion of the loan is retained upfront and monthly payments are required for the remaining portion of the loan. This can be beneficial for a BRRR (Buy Refurbish Rent Refinance) strategy, as once the property has been refurbished and rented, the borrowers can service the interest, reducing the amount of interest paid on the loan.

Retained Interest Bridging Loan

Retained interest refers to the practice where interest on a loan is not paid on a monthly basis and instead, the entirety of the interest accrued over the term is deducted from the initial bridging loan amount, covering all of the interest payments for the term of the loan.

As a result, you are required to repay the capital borrowed, fees and interest used at the end of the loan term in a balloon or bullet-style payment.

A balloon or bullet-style payment refers to a singular repayment covering the principal, interest, and fees of a loan either upon or before its maturity date, usually by either sale or refinance of the asset. This stands in contrast to a serviced loan, where payments are made periodically through instalments over a designated period.

Retained interest is calculated using the following formula:

Retained interest = Gross Loan × (Interest rate per month × number of months)

Applied Example:

To understand retained interest, consider a scenario where a £1,000,000 loan is acquired for 10 months at a monthly rate of 0.5%.

For simplicity, let's assume there are no fees or additional costs in this example:

The monthly loan cost amounts to £5,000 (£1,000,000 × 0.5%) per month.

Instead of making monthly payments, the lender collects 10 payments upfront, covering the loan interest for the initial 10 months (£5,000 × 10 months = £50,000). This upfront payment represents the retained interest, a principle that also applies to retained fees.

The net loan received by the borrower is calculated as Gross Loan minus Interest, resulting in £1,000,000 - £50,000 = £950,000.

Consequently, in the absence of further fees, the borrower repays the gross loan of £1,000,000 on the loan’s maturity. Repaying the net loan borrowed (£950,000) plus the interest owed to the lender (£50,000).

If repayment occurs sooner, such as after 5 months, the borrower would only repay £975,000 (£950,000 + (5 × £5,000)) = £975,000.

If you want an instant bridging loan quote apply here.

Exit Fee

An exit fee is a charge applied by the lender upon repayment of the loan. It serves to enhance the rate of return for the lender and is charged at exit regardless of the duration.

Exit fees typically range between 0.5% to 2% of the gross loan amount if imposed by the lender. Unlike some other fees, the exit fee is not retained, meaning it is not deducted from the gross loan before completion.

Exit Fee (£) = Gross Loan (£) × Exit Fee (%)

This fee should be carefully considered when evaluating the cost of a loan, as it can significantly increase the overall repayment amount, making a seemingly "cheap" loan more expensive.

At Aura Capital, we offer a variety of options without exit fees or similar subtle charges. Additionally, we have negotiated improved terms for our clients seeking to avoid these charges altogether.

Valuation Fee

The valuation fee is a payment made directly to the lender to cover the expenses associated with a property valuation. In certain instances, this fee is paid to a valuation panel manager who organises and compensates a third-party valuer.

The cost of a valuation depends on various factors such as the property type, condition, location, value, demand for valuations, and the chosen methodology (e.g., Red Book or Short Form). Valuation fees range from £350 for ‘No valuation’ or desktop valuation loans up to £20,000 for multi-million-pound development applications. The average valuation fee for a bridging loan is around £900-£2500 depending on the application.

Aura Capital collaborates with several national valuers who operate on a fixed fee scale directly and are approved on the majority of lenders' panels.

Arrangement fee

The arrangement fee, also known as a completion fee or product fee, is a charge levied by the lender for arranging the loan.

In the current specialist finance market, the market standard for this fee is typically 2% within the bridging market.

The arrangement fee is subtracted from the Gross Loan amount, thereby diminishing the net loan amount received by the borrower.

The calculation for the arrangement fee involves multiplying the gross loan by the percentage determined by the lender.

Arrangement Fee (£) = Gross Loan (£) × Arrangement Fee (%)

It's essential to note that brokers often receive between 50-100% of the arrangement fee, this is known as the procurement fee.

For example, if the arrangement fee is 2% and the broker's procurement fee is also 2%, the lender is paying 100% of the arrangement fee to the broker.

The lender is legally obligated to disclose any commissions and fees they are paying to the broker. If they are hesitant to provide this information in writing, it's advisable to scrutinise your terms thoroughly and contemplate exploring alternative options.

Net Loan

The net loan amount, often referred to as the principal loan amount, is the actual loan amount that the client will receive. Typically, borrowers receive between -5% to -10% below the Gross loan amount in terms of loan-to-value ratio.

The formula to calculate the net loan amount is as follows:

Net Loan = Gross Loan − Retained Interest − Fees & Costs

This calculation deducts any retained interest and fees/costs from the gross loan amount, resulting in the final amount that the borrower will receive.

Title Insurance

Title Insurance is a policy commonly required by bridging lenders to streamline and reduce the risk of the legal and title process. It simplifies the legal procedure by providing insurance coverage to the lender against title issues, search problems, and other property-related matters, thereby also protecting the borrower. This type of insurance can also help diminish the need for conventional conveyancing and property-related searches, resulting in cost savings for borrowers and potentially expediting the legal process.

Title insurance costs can fluctuate between £350 and £1750, determined by the property value. Additionally, lenders may profit from the title insurance as part of the policy setup expenses.

Administration Fee

The lender's administration fee covers the administrative expenses involved in processing a loan and is distinct from an Arrangement Fee. Typically, this fee encompasses costs such as credit checks, property visits, Automated Valuation Methods (AVM), loan management software, and fixed operational expenses incurred by the lender.

Administration fees usually fall within the range of £375 to £5,000. While these costs are often deducted from the gross loan amount, some lenders may opt to charge them upfront as a 'commitment fee'.

When considering a bridging loan, it's essential to carefully assess all associated costs and compare your options. Breaking down the loan into its various fees and interest components reveals that seemingly more affordable lenders may have numerous fees that borrowers frequently overlook.

Legal Fee

The legal fee is a charge imposed by the lender to cover the expenses incurred by their legal team. It's essential to understand that this fee is distinct from your own legal costs.

Legal fees typically amount to around 0.25%-0.35% of the gross loan amount. However, if you're dealing with multiple properties, your broker, particularly if they specialise in bridging or development finance, may be able to negotiate a discount on these fees.

While the legal fee is ultimately retained by the lender and deducted from the gross loan as part of the loan agreement, it's crucial to note that the legal fee is usually required to be paid upfront as a deposit, referred to as an 'undertaking.' This undertaking ensures that the lender's legal team will be compensated if either you or the lender withdraws from the transaction.

Bridging loans without legal fees are also available depending on the circumstances of the loan and the lender.