Can bridging loans be used as a property deposit? Generally, yes, but it’s vital to go about it the right way. In this guide, we discuss everything you must know about using bridging loans for property deposits.
Expanding your property portfolio or purchasing an extra commercial building to grow your business is an intelligent way of scaling quickly. However, the barrier to expansion is always obtaining financing and securing the cash flow needed to get approved for that financing.
Bridging loans are a popular option for a variety of purchases to help you bridge the gap until you can secure a long-term financing solution. Can bridging loans be used as a property deposit? Generally, yes, but it’s vital to go about it the right way.
In this guide, we discuss everything you must know about using bridging loans for property deposits.
What is a bridging loan used for?
Bridging loans are short-term secured loans that enable borrowers to buy something at short notice.
They can be used for just about anything, with different products going under fancy names. For example, you may have heard about auction loans, but these are essentially just ordinary bridging loans designed to purchase properties at auction.
We’ve seen bridging loans grow in prominence in the UK property sector. During the property boom of 2022, Q1 2022 saw the value of bridging loans increase by 8.5%. As you can see, bridging loans are highly versatile products for investors, landlords and businesses in the property market.
Some of the ways you can use them include:
It’s why 2023 saw a record £831 million in bridging loans transacted by lenders in the UK as more people turn away from traditional financial products.
Can you use a bridging loan for a deposit?
Bridging loans can be used as deposits in some circumstances. Ordinary first-time residential purchasers can’t use them for deposits because no mortgage lender will accept a deposit directly from another lender. The point of a deposit is that an external lender isn’t taking all of the risk.
Generally, bridging loans cannot be used for making direct cash deposits, but they can be used to release equity from existing properties. Bridging loans themselves are secured against a high-value asset, allowing you to unlock some of the equity you’ve already built up.
For example, a commercial landlord may secure a bridging loan against an existing unmortgaged property to release cash from that property on a short-term basis. The cash they release can then be used to secure a mortgage deposit.
Note that this doesn’t mean you can avoid putting down any cash at all to fund a property purchase. Bridging loans still require deposits themselves, which typically amount to 25% of the total gross loan.
On the other hand, it can enable you to pay less. For example, let’s say your mortgage lender asks you to put down £40,000 to secure a commercial mortgage. Instead, you can obtain a bridging loan to pay for it. A £40,000 bridging loan might have a 25% deposit requirement, meaning you actually only need £10,000 instead of the original £40,000.
As you can imagine, this is highly beneficial for businesses, landlords and investors alike on a larger scale.
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How does a bridging loan for a property deposit work?
Bridging loans for property deposits relies on having existing equity in a property to work alongside a traditional mortgage lender.
Remember, you can’t fund a traditional mortgage deposit using another lender directly because these lenders won’t accept the charge being levied against the property they’re providing a mortgage for.
So, how does it work?
1. A borrower will approach a bridging loan lender to get funding for a property deposit.
2. The borrower will use another property to secure that bridging loan against. Essentially, they’re releasing equity they already have.
3. The money can then be used to fund a traditional mortgage deposit.
4. The bridging loan is then paid off later through a viable exit strategy, such as refinancing through a traditional mortgage or selling the other property.
The reason why it works like this is because the bridging loan lender’s charge isn’t on the same property you’re applying for a mortgage for. In other words, it doesn’t interfere with your mortgage provider’s business.
It’s an arrangement that has several benefits for businesses, including:
Naturally, there are downsides. Bridging loan rates are higher than standard mortgages and you’re under pressure to act fast due to the short-term nature of these loans. This is why speaking to a specialist financial advisor before acting is vital.
Bridging loan for a deposit: An example
Let’s use an example of how a bridging loan might work in practice for a business looking to secure a new manufacturing facility for £2 million. They must put down £500,000 as a deposit to get approved for a commercial mortgage.
Here’s the financial breakdown for Manufacturer X:
Manufacturer X knows they need £500,000 to secure the property while they arrange a long-term commercial mortgage to cover the £2 million value of the property.
They secured a bridging loan of £500,000, which was secured against an existing manufacturing facility. In this case, their exit strategy is to refinance into a long-term mortgage, enabling them to repay the bridging loan plus interest.
The lender approves their bridging loan and it’s secured against the existing manufacturing facility. If, for any reason, Manufacturer X cannot repay the bridging loan, this facility could be seized and sold to repay the loan. During their loan term, they work with a bank to get approved for a £2 million commercial mortgage to complete the full purchase of the new facility.
Once approved, Manufacturer X uses the mortgage to pay off the bridging loan plus interest. They then have their new manufacturing facility with a traditional commercial mortgage attached.
Likewise, Manufacturer X could use the same strategy but use the sale of their older facility as their exit strategy. It’s the flexibility and versatility of bridging loans that gives businesses like Manufacturer X a variety of options.
At Hilton Smythe, we know how complicated financial planning can be, especially when using different financial products. If you’re looking for tailored advice or seeking support with obtaining financing for your next business expansion, speak to the team with decades of experience today.