Property investors of all kinds often find themselves in need of quick funds to bridge gaps in cash flow. This is part and parcel of juggling a portfolio that includes multiple properties. Investors may also find it useful to have a short-term funding option close to hand, in order to compete with cash buyers when an unexpected investment opportunity presents itself.
Short-term financing might be needed for a variety of purposes, including the purchase of a property before the sale of another completes. Funding might also be needed for the purchase of an auction property, paying renovation costs to bring an uninhabitable property up to a mortgage-able standard or simply covering unexpected building costs during a renovation.
As with any financial product, it’s important to read and carefully consider terms and conditions, as these vary from lender to lender.
Borrowing from personal savings
If you have cash in a personal savings account, it may be tempting to raid this in order to push a property investment project through to completion or to acquire a new property.
As you’re borrowing from yourself, no interest will be added, and the funds can be paid back as and when you have recovered costs, perhaps when a property is sold, or through rental income, over a period of time.
If you’re trading under a limited company structure, tax law dictates that you must formalise any such funds transfer, labelling this as a ‘directors’ loan’ to keep matters above board.
If your savings are held in an account that relies on a minimum investment term, you may lose interest by transferring funds, so be careful to check out the potential ramifications before you do so. You may lose the tax benefits you have built up in ISA’s and other tax efficient funds too.
A bridging loan is a short-term loan taken out to cover the interval between two transactions, typically the purchase of one property and the sale of another, or the purchase, renovation and resale of a property, for a higher amount.
Bridging loans have some similarities to mortgages, albeit short-term ones. Like mortgages, the amount you’re allowed to borrow is usually dependent on the value of the property you’re borrowing against. The property is also used as security for the loan, so if you fail to meet repayments, the lender may repossess and sell it to cover the debt.
Bridging loans are also like buy-to-let mortgages in that interest is paid over the loan term, with the capital payable in a lump sum as the term comes to an end.
There are also some fundamental differences, however. The most obvious of these is the term – a mortgage usually spans 25 years, or longer, while the average bridging loan duration is 12 months.
Another major difference is the cost of borrowing. Currently, most mortgage rates come in under 5 per cent of the total amount borrowed. Bridging loan interest rates, however, start at around 8 per cent and can be as high as 15 per cent or even more.
Finally, bridging loans are extremely quick to arrange, taking only a matter of weeks, if not days, to be put together.
Often, the purchase of one property is dependent on releasing the capital from another. If a sale hasn’t been finalised when a purchase must proceed, temporary finance may be needed to ‘bridge’ the gap.
Short-term bank loans
If you have a good credit rating or a great relationship with your bank, built over a long period of time, you may be able to secure a short-term business loan.
While a personal loan is a possibility, property investors should not rely on these as a regular strategy of short-term funding, as interest rates and fees can be very high. The long, drawn-out nature of personal loan applications can also mean that you are unlikely to get your hands on your cash very quickly.
As with all loans, you should only borrow what you need and make sure that you can comfortably meet repayments. You should also be aware that applying for and being refused personal loans can affect your credit rating.
Second charge mortgages
If you already have a mortgage in place on a property, you may be able to increase the amount already borrowed under that loan (known as re-mortgaging).
This isn’t always a practical option for property lenders, as your circumstances may have changed since the initial application for finance was made, meaning that you may no longer meet the lender’s borrowing criteria. Rearranging the loan may also mean submitting to a large hike in interest rates, or an early repayment charge being applied.
In these circumstances, a second charge mortgage may be a better option. This involves taking out another loan from a different lender that sits on top of your current mortgage. Buy-to-let investors often make use of this type of loan to release some of the equity from a current rental investment property and use this to fund the purchase of another.
Should you default on your borrowing, your original mortgage provider will be first in line to recover their debt through the repossession and sale of your property. Your second lender is therefore last in line, and open to more risk. For this reason, they will charge higher interest rates and fees, in order to reflect this position.
Factoring short-term loans into your investment strategy
Unfortunately, due to the increased risk of short-term borrowing, property investors may find themselves facing high interest rates and fees on any borrowing that’s done with little time to spare.
The important question for investors to ask is whether they can expect a return on investment that justifies the high cost of this type of borrowing. Often, this is the nature of the beast, and although investment levels are high, returns are also generous, justifying the action in the long-term.
If you’re in doubt regarding the best option for your personal circumstances, you might wish to consider consulting a financial adviser, who can help you decide on the right course of action.