Bridging loans: tread carefully

published 13 March 2009

You've just found your perfect home after months of searching. Even better, you've managed to haggle it down to a bargain price because the seller is desperate to move. You're ready to do the deal. There's just one snag: you can't sell your old house. Now you're terrified that a cash buyer will come along and steal your dream home while you're still frantically polishing the for-sale board and dragging strangers off the street to show them all that extra space in your loft conversion.

One tempting solution is to use a bridging loan, where a bank lends you money to buy the new house before the old one is sold. This is a fairly obscure type of finance, but it seems to be getting a bit of publicity and is likely to get more as the property market remains stagnant and sellers get ever-more desperate.

Bridging loans have traditionally been rather expensive, but the Bank of England's rate cuts have brought them down to levels where many people might be tempted: 1%-2% over base rate plus a 0.5%-1% arrangement fee, according to Lloyds TSB, which seems to be the cheapest on the market. RBS also offers them, but few other high-street banks and mortgage advisers are keen. Specialist bridging finance firms, serving both commercial and private borrowers, have sprung up, but tend to be very expensive in the region of 1% a month, plus fees.

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Strictly speaking, there are two types of bridging loan. Closed bridging is used when you've already exchanged contracts, but are unable to complete both the sale and the purchase on the same day, leaving you with a financing gap of a few days. This type of finance can be useful: if you're dealing with a long chain it can be impossible to get everyone to complete on the same day, and if one or two buyers agree to bridge, it can split the chain into manageable chunks. Here you're borrowing for a short, fixed period, so your risks will be limited and a bridging loan may be a reasonable option (but do talk it through carefully with your mortgage adviser first).

The other type of loan, which would be of more use to someone struggling to sell their first property, is open-ended bridging (OEB). While it may look attractive as a way to end your frustration at not being able to sell, we'd advise against it. OEB ish much more dangerous. Here, you take out a loan to buy the second home without having exchanged contracts to sell the first. Clearly, this is extremely risky: you've an open-ended commitment to pay mortgages on two properties, with no certainty as to when you'll be able to sell your first house and pay off one of the mortgages. This applies even if you have a buyer lined up; up until the point when they exchange contracts, they can and frequently do walk away.

You may well struggle to sell your property if you couldn't do it before taking out a bridging loan, why would it be easier afterwards? You're doubling your exposure to a property market that is nowhere near hitting bottom, and could end up in negative equity on both houses. And if interest rates start rising again before you sell, you'll have two sets of rising payments so what seems affordable now may quickly become a burden.

Royal Bank of Scotland has pledged to issue £1.7bn worth of mortgages into the Scottish housing market over the next year. The bank said it would offer customers mortgages worth up to 90% of a property's value in order to help first-time buyers get on to the property ladder. "Our message to customers in Scotland is very clear, we are now, more than ever, open for mortgage business," Paul Geddes, head of consumer banking at RBS Group, told the BBC.

Property sales sank to a new low in February, according to the Royal Institution of Chartered Surveyors (RICS). The average estate agent agreed just 9.5 sales in the three months to the end of February. That's the lowest since the RICS survey began in 1978. However, the survey reported that inquiries from new buyers increased for the fourth month in a row. "Potential buyers continue to come through estate agency doors, but without mortgage finance, transaction levels are likely to remain close to all-time lows," said RICS spokesperson Jeremy Leaf.

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.