Difference Between Bridging Loans And Development Finance

Introduction

Both bridging loans and development finance are important financing options available to property investors and developers. While they have several similarities, they have different applications.

It is important to understand the differences between bridging loans and development finance.

Bridging Loans

Bridging loans are a short term financing tool used to “bridge the gap” between a current expense and a future cash flow. Bridging loans are commonly used in the UK, and are a useful tool for property investors and developers. There are hundreds of different bridging loan lenders, each with their own products.

While these products may differ, there are a number of similarities that all bridging loans will share:

Purpose: Bridging loans can be used for a number of reasons, from property refurbishments to planning applications, however, the most common use is the purchase of a property prior to the sale of an existing property. Property owners and landlords often find themselves in a position where they are presented with a limited time opportunity to purchase a new property, prior to the sale of an existing property. While some landlords may have the funds to purchase the new property outright, others will require a release of funds from their existing property. With this in mind, property bridging loans can enable borrowers to quickly release funds from their existing property and take advantage of the opportunity to purchase a new property, without having to wait for the sale of their existing property.

Once the new property has been purchased, the bridging loan will be repaid through the proceeds of sale of the previous property.

Other uses of bridging loans include:

●     Refurbishments

●     Property Refinance

●     Auction Purchases

Term: The term of a bridging loan is generally short, between 1 and 24 months, with some lenders offering longer term products. One of the reasons for their short term is the fact that they are not designed to be permanent solutions and, as such, they have higher interest rates. Moreover, bridging loans are often riskier for the lender than traditional mortgages, which means they limit the time to which they are exposed to this risk.

Repayment: The repayment of a bridging loan is an important consideration for lenders, who often place great importance on the intended repayment strategy. Generally bridging loans will be repaid from the proceeds of sale from another property or from the borrower refinancing onto a traditional mortgage.

Interest: Interest rates on bridging loans tend to be higher than traditional mortgages as a result of their risk profile and short term nature. Interest on bridging loans can be retained or serviced. Serviced interest is where the borrower makes regular payments to the lender as compensation for the borrowed funds. Retained interest is where the interest charges are rolled-up and repaid in one lump sum payment at the end of the loan term.

Development Finance

Propose: Development finance facilities are used exclusively to fund property developments. This includes the purchase of land or an existing property with the intention to redevelop/develop. Development finance is offered by a number of lenders, from high street banks to specialist development finance broker. A development finance facility would commonly be structured in different tranches: an initial release of funds to assist with the purchase of the site/property; a subsequent release of funds to assist with the construction of the property. Given the specialist nature of development finance, lenders often have a higher degree of involvement in the project. Lenders will generally appoint a surveyor to ensure that the project is regularly reviewed against its expected timeline/construction schedule.

Duration: Property development finance is often aligned with the development schedule. This means that the funds will be released in tranches that align with the different construction stages. For example, an initial tranche of funding might be released to cover the purchase of the property, with another, subsequent tranche being released to cover the groundwork of the development. Timing the release of funds with the construction schedule can be tricky for lenders, and so it is important that they have an in-depth knowledge of the construction stages. For this reason, lenders will generally appoint a surveyor to monitor the timeline of the project and ensure that the funds are released at the right time.

Repayment: There are a number of ways in which developers can repay development finance:

Proceeds from sale/presale: Upon completion developers will either sell the property or rent it out. The proceeds from sale, or presale, of the property/properties, can be used to repay the development finance facility.

Bridging Loan: If the borrower is unable to repay the development lender with the proceeds of sale, a bridging loan is an attractive option. Developers can secure a bridging loan on the completed property, the proceeds of which can be used to repay the development finance lender. A bridging loan will enable the developer enough time to refinance the property onto a longer term mortgage.

Traditional Mortgage: Once the development has been completed, the developer can refinance the property onto a longer term traditional mortgage, using the funds to refinance the development finance lender. While this may be an attractive option for developers, it may not be feasible due to the fact that it generally takes longer to acquire a traditional mortgage and the developer may need to get a bridging loan to repay the development finance lender before refinancing onto a traditional mortgage.

Flexibility: Given the structured nature of a property development, development finance is not generally very flexible. Development finance often relies on major construction milestones in order for additional funds to be released. This may put the developer in a tricky position should the development fall behind schedule or encounter unplanned expenses. It is important that the developer allows for adequate time and cost contingencies to ensure that the development runs smoothly.

Conclusion

There are a number of differences between bridging loans and development finance all of which should be considered prior to approaching a lender. It is important that developers consult with their development finance broker in order to better understand their options. Moreover, a independent mortgage broker can help their clients understand which type of finance is best suited to their needs and which lenders to approach.