Deciding on the most suitable finance facility for your new development or refurbishment project, can be a difficult task for both experienced and inexperienced property developers.
This guide will go through the main aspects of the two facilities most often used by property developers, bridging loans and development finance, to help you decide which option is the most suitable and cost effective for your project.
Bridging finance is a flexible short-term finance solution which is traditionally used to ‘bridge’ the gap in finances before money that the borrower is expecting becomes available. Due to the flexibility of bridging loans can be used for almost any type of property transaction, including developments, renovations and extensions.
One advantage to bridging is that it can be sourced and arranged much faster than other types of finance – sometimes the money can be in your bank within 48 hours, dependent on your circumstances.
As bridging is a short-term facility (usually 12 months or less), having a secure exit strategy is key. This could be the sale of the development, or an alternative long-term finance solution, such as a buy-to-let or commercial mortgage.
This type of facility is particularly popular with property developers because loans are based on the value of the security. Property in a poor state of repair, derelict or even plots of land are not an issue for specialist bridging lenders.
What types of development can a bridging loan be suitable for?
Bridging can be suitable for almost any type of property development, from small extensions and interior renovations, to large scale commercial development projects.
However, keep in mind that you should only use a bridging loan for projects which can be completed in the shorter 12 to 18 month timescale, unless you have another source of funding in place to repay the bridging loan and carry on the development when the bridging term ends.
How much will a bridging loan cost?
The interest charged on a bridging loan can cost somewhere from 0.4% to 1.25% per month, but this will depend on Individual circumstances, and is usually applied to the loan facility on a monthly basis. You won’t be required to pay off the loan in monthly instalments as the interest and capital can be paid back at the end of the term with your planned exit strategy. To find out the interest rate likely to be charged, use this online bridging loan calculator.
There will also be an arrangement fee, which is usually around 2% of the gross or net loan amount, and this can also be added to the loan facility and paid off at the end of the term. Other fees that may be payable include valuation fees and legal fees.
What is the lending criteria for bridging finance?
Lending criteria to qualify for a bridging loan is generally more flexible than a lot of other finance facilities. Your income will not usually be assessed, as the security available and having a viable exit strategy are the two most important factors.
Bridging lenders will generally be able to lend to inexperienced property developers for low-risk projects if those two important factors are in place. However, the project must make sense, both practically and financially. There is no point entering into something that is risky or has a good chance of failure.
The maximum Loan to Value (LTV) tends to be 70% to 75%.
Development finance is a facility designed specifically for property development projects. Often used to fund small renovation projects, but more typically used to fund whole projects from the land purchase to all the building and building work of ground-up developments.
With a longer term available, usually up to three years, development finance is suitable for large projects as it can also provide the largest finance facilities with the highest loan to values. Use this online development finance calculator to work out how much you can borrow and what you will be charged.
Instead of being paid out in one lump sum, the funds will often be released in stages in line with the building work.
What is the lending criteria for development finance?
Unlike bridging, lenders of development finance will consider your experience as a developer to be vital and evidence of what projects you have done in the past, and how successful they were, will be required. This will need to include what profit you made and how the overall project was conducted.
The maximum Loan to Value (LTV) is typically 70% of the Gross Development Value (GDV) of the project.
How much will development finance cost?
The interest on a development finance facility can cost between 4% – 15% per annum – the amount charged being dependent on the Loan to Value, the loan size, the type of project, and your experience in property development. The interest charged will usually be added to the facility on a monthly basis.
An arrangement fee will also be added to the facility, usually between 1% – 2% of the gross or net loan amount, and this is charged by the lender for arranging the loan. Valuation costs will also need to be paid upfront – this will determine the value of the development site at the beginning of the project, the approximate costs and time the project is likely to take and how much it will be worth when it’s complete.
Unlike bridging, there will also be monitoring fees to pay. The lender will send surveyors to the development site throughout the construction process to assess the progress that you’re making. It’s vital that these visits go to plan because they will determine future fund releases if you have a loan that is being paid out in stages.
Keep in mind that there may also be legal fees and exit fees.