Property finance has many uses in the UK, with increasing numbers of people seeking out specific forms of this specialised type of secured loan for their specific needs and circumstances. There are however, cases where time is of the essence; this can be in the case of property investments as well as private buyers looking to secure their dream property for them and their family’s future.
Generally, the finance required to purchase a property will be one of the following:
- Traditional Mortgage
- Bridging Finance
- Auction Finance
In past times, apart from an everyday mortgage, which secures a substantial loan amount against the value of a percentage of your property’s equity, there was little to choose from. Therefore, when it came to improving a property’s value or investing in property otherwise, raising the money needed was incredibly difficult.
Nowadays, specific forms of property finance exist to cover many uses for the money secured ranging from development finance of millions of Pounds to develop hotels to agricultural finance to develop a farm business in the UK (source: Straw Spreader). However, if you are suitable for some of the most widely used types of property finance, understanding their basic principles and how they work is important.
Traditional Mortgages in the UK
Traditional mortgages are the most widely utilised for of property finance by far in the UK and around the world. For the majority of borrowers of this type of secured loan, the reason for requiring such a large amount is to purchase their home.
In recent years, banks and lenders have relaxed their lending criteria slightly but for the most part there are various criteria that a prospective borrower must meet before being accepted for a regular mortgage:
- Be a UK resident
- Older than 18 years
- A minimum salary of around £20,000 per year
- Borrowers should have a deposit [down payment]
- Not having entered bankruptcy or an Individual Voluntary Agreement (IVA) within the last 5 or more years
Once the basic criteria have been met and the borrower is accepted for a mortgage, they will need to keep up with their regular (usually monthly) repayments until such time their debts are cleared.
How Does a Mortgage Work?
The basic premise of a regular mortgage is that the loan is taken out against a property. This means that should the borrower default, they risk losing their property to the lender who would then sell it to recoup their losses. For example, a borrower may be looking to buy a property worth £500,000. They have savings of £150,000 which will cover their deposit. However, they will need to pay the remaining £350,000 and this is where the mortgage comes in.
The bank or lender, having accepted the applicant will provide the money needed plus interest over an agreed amount of time, say 10 years. The borrower must then repay this debt over that time. Should they decide to sell their property before the end of the mortgage term, this will need to be agreed with the lender. Upon the property being sold, the borrower will need to pay off the amount owed to the lender first, keeping the necessary amount thereafter depending on the percentage of the property’s equity they own.
Bridging Finance in the UK
Bridging finance is a form of property loan which is utilised in cases where time is of the essence and a quick loan for a property is needed. One of the most common examples of how this specialist type of finance is used is when there is a break in the property ‘chain.’ This may mean, that a vendor’s subsequent purchase of a new property is dependent on a buyer purchasing their property.
For example, a property owner may be looking to upsize their property; their current property is worth £500,000 and the new property they have found costs £750,000. Having found a buyer, they are ready to sell and use their sale amount for the new property. However, at a late stage of the process, the buyer drops out, ‘breaking the chain.’
Hence, the property owner may well lose out on their new property without a buyer being found quickly as they cannot afford to pay £750,000 outright. In such cases, a bridging loan can be provided quickly; the loan covers the entire purchase amount of the new property. Then, once the first property is sold, the sale amount goes towards the bridging loan and the new property is remortgaged to make up the remaining capital and interest of the bridging loan.
What are the Drawbacks of Bridging Loans?
Although bridging loans serve very worthwhile causes, they do have a few potential drawbacks to be aware of and they are not always suitable for everyone:
Interest Rates – Although all property finance types will have interest to pay, as a specialised form of property finance and because they are usually provided quickly, often at greater risk, bridging loans do command higher than normal interest rates compared to regular mortgages. Additionally, if you secure the bridging loan through a broker, you will likely have to pay broker fees too.
Exit Strategy – Bridging loans require the borrower to have a viable exit strategy. This refers to their strategy with which to exit the loan. Usually it will entail the sale of a property and the subsequent remortgaging of another to repay the loan. This is typically referred to as an ‘open loan’ as the strategy is viable and in place but not necessarily with a concrete time frame. However, sometimes there is a more decisive strategy.
For example, the borrower may be selling off high value assets, with a sale being completed by a predetermined date and therefore the bridging loan guaranteed to be exited by then. In these cases, the strategy is likely to cause the loan to be ‘closed.’
Specialist Lenders – Applying for a normal mortgage tends to be easier and more straightforward than for a bridging loan. You may also find that you will need to go via a specialist broken in the case of a bridging loan and this will usually be more expensive.
How Does Auction Finance Work?
Property auctions are very exciting as well as tense and often, high pressured and auction finance helps numerous purchasers in the UK on a regular basis. It is possible to secure a real bargain as these properties often need to be ‘disposed’ of to fulfil probate or debt requirements, so their reserve prices are usually lower than if they were entered onto the mainstream property market.
In cases of property auctions, unlike other property purchases, the legal contract and the purchaser’s obligations begin as soon as the gavel falls. Furthermore, there will usually be registration fees whereby you will need o register with the auction house in order to partake in the auction. As soon as the gavel falls, the person with the winning bid must pay 10% of the property value there and then as well as any required auction house fees.
From the point of the deal being sealed, the buyer then has 28 days to pay off the outstanding 90%. It is very likely that the majority of this amount will come from an auction finance provider who will fund an agreed amount. In cases of ‘Status’ lenders, who are authorised by the Financial Conduct Authority (FCA), they will usually not lend more than 70% of the amount required, so the borrower will need to account for the remaining 20% of the outstanding 90% of the property value.
However, non-Status lenders, who will usually not carry out the same financial checks as Status lenders are more likely to be able to fund more than the 70% of a Status lender, although they are likely to be more expensive with higher interest rates.
Therefore, most borrowers of this form of finance will remortgage their new property as soon as they own it in order to repay their auction finance lender and start making repayments on a regular mortgage with more favourable and more affordable interest rates.
When Can I Apply for a Second Mortgage?
Although traditional, bridging and auction mortgages are some of the most popular types of property finance in the UK, there are in fact many other specific types of finance which can be used for all nature of property-related purposes.
One of the most popular types of these mortgages is a second mortgage. These forms of property finance entail a second mortgage lender agreeing terms with both the borrower and the principle [first mortgage] lender. Second mortgages are usually used for any of the following:
Business Expansion – It may be that the borrower needs an injection of money for a business venture. A second mortgage could, if the business has high potential, be able to provide the necessary funding to start or expand the business in question. For example, a business may need to buy an increased number of children’s gifts around the Christmas period (source: Cotton Twist).
Home Improvement – Improving a property can increase its overall resale value. Therefore, lenders are often willing to provide a second mortgage to this end. You may be converting the property into two living units to increase the rental yield. Alternatively, you may simply wish to add a loft conversion to your home, which in itself could increase your property’s value by more than 20%.
Debt Consolidation – Managing numerous debts simultaneously can be very difficult and may in fact be harder to manage than a single, manageable yet larger debt. For example, you may have debts outstanding with credit card, utilities and loan providers which you are struggling to manage. If you own your property, a second mortgage lender may be able to lend you the money you need to pay off your debts in the immediate term.
Thereafter, you will then be required to repay your mortgage providers with the first charge mortgage provider getting precedence. However, in the long run, this may prove beneficial with you being able to clear your debts and achieve a degree of financial security and breathing space.