Within the property development sector, bridging loans and development finance are the two primary lending tools to kickstarting projects; but what’s the difference between the two?
Property development unlocks lucrative opportunities for businesses at every stage of their journey. However, most businesses either lack the capital to pay for entire projects upfront, or paying upfront does not align with their strategies.
According to the Office for National Statistics, 65% of businesses reported having some concern for their firm. Chief among these problems is financing to fuel growth. Within the property development sector, bridging loans and development finance are the two primary lending tools developers use to get projects off the ground.
But what’s the difference between the two? Here’s what all developers should know about these products.
What are bridging loans used for?
Bridging loans
are short-term financing solutions to bridge the gap between purchasing or refurbishing a property before a long-term financial solution can be found. They enable developers to move faster and avoid missing out on opportunities caused by lengthy loan application processes.
However, the key to these loans is surviving with a short timeline. Firms must have an exit strategy with a realistic timeline or risk finding themselves in financial distress later.
What is development finance?
Development finance works similarly to bridging loans, but offers less flexibility. In many cases, they will also offer greater sums, with seven-figure loans not being uncommon within the residential and commercial development finance sectors.
Whether a developer is constructing a new property from scratch or converting an existing building, these financial packages are tailored to the project. Due to the non-standard nature of these loans, they’re more complicated and usually more time-consuming to arrange.
All lenders have limitations, but most UK lenders offer up to 65% of the Gross Development Value (GDV) for the land or property purchase and 100% of the costs. Developers must fund the 35% shortfall via other means, such as mezzanine debt.
A key element of development finance is that it’s technically two loans:
- 1Site purchase loan
- 2Construction loan
The construction loan element is paid in defined stages called tranches that align with the build timeline of your project.
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When to use development finance
Development finance is primarily used for three purposes:
- 1Purchasing land/existing buildings.
- 2Property renovation.
- 3Property conversion.
The longer loan terms on development finance make them more suitable for these projects than bridging loans, which often only remain active for a maximum of 12-18 months, depending on the lender.
Are the lending criteria for bridging loans and development finance different?
Lending criteria for bridging loans and development finance differ because they have separate purposes and risk profiles. Of course, there are similarities, too, which is why if you qualify for one, there’s a good chance you’ll also qualify for the other.
Here’s a comparison between the two.
Bridging loans lending criteria
Development finance lending criteria
Funds release process: bridging loan vs. development finance
A core difference between bridging and development finance is how funds are released. Once you’re approved for a bridging loan, you’ll receive the entire loan amount within a few days. The speed of approval and funds release is what makes bridging loans so popular.
Development finance funds are released in stages. The lender will only release enough capital to fund the next stage of purchase/construction. Each tranche will only be released after an independent monitoring surveyor visits the site and confirms the work has been done.
The point of this staged release process is to protect the lender when projects don’t go according to plan.
The main differences between bridging loans and development finance
Development and bridging loans have much in common. They’re short-term financing options that are secured against a high-value asset. You’ll avoid making monthly repayments and, instead, pay them off as a single lump sum at the culmination of the loan term.
However, they do have differences, which is why developers use them for different projects. Sometimes, they might even use both on a single project. In reality, there are three main differences.
Payout speed
With bridging loans, the funds will be dispensed faster than with development loans. A bridging loan can be acquired in 10-14 working days, depending on the lender and how smoothly your application progresses.
Of course, bridge loans are only designed to bridge an existing funding gap, so be prepared to pay them back within just a few months.
Flexibility
Bridging loans can be used for any number of purposes. Your lender doesn’t really care as long as you have a viable exit strategy. In contrast, development loans are usually restricted to new builds and redevelopment projects, like conversions and refurbishments.
Payout structure
Bridging loans are dispensed as part of a single lump sum without external monitoring. Development loans are set up in stages, with funds released only as you complete each defined stage of a project. If there are delays or the project falls through, your lender can slam the brakes on and bring a complete halt to any payments.
Of course, the payment staging used in development loans can also benefit you as the borrower. Rather than taking out everything at once, you can withdraw funds as needed. For example, you don't have to take the full amount if you’ve overestimated how much you need to complete a particular stage.
Deciding which loan type is right for you can be tricky, and then you must go through the hassle of sourcing reliable lenders. At Hilton Smythe, our independent financial experts are ready to point you in the right direction, providing tailored help to get your project on track. To learn more about what we do, get in touch and speak to the team today.