What is the difference between bridging and development finance?

Knowing the different types of finance available for property development is key when it comes to choosing the right funding for your project. We're looking at the differences between development and bridging finance and how they are both used.

What is a bridging loan?

So, what is a bridging loan? A bridging loan explained simply is a short-term loan, usually 18 months or less, that can alleviate temporary funding gaps between buying and selling property.

Bridging loans must be secured against assets, usually property, but can be other high-value items and typically require a Personal Guarantee. If the borrower defaults on the loan, lenders can take possession of these assets. When using a bridging loan for property development work, the amount that can be borrowed depends on the value of the securing assets.  They are mostly limited to 75% gross LTV (including interest and fees).

Key features of a bridging loan:

• quick arrangement, from 3 days to 3 weeks
• provide borrowers with immediate liquidity
• vast borrowing scale from £10,000 to £50m
• can be unregulated, meaning less bureaucracy
• available for both commercial and residential properties
• no early repayment charges (although some carry a minimum loan term)

There are two types of bridging finance:

• Closed-bridge loans have a set date for repayment due to a defined exit strategy.
• Open-bridge loans have a proposed exit plan for repaying but a definitive date is not set.  Though there will be a cut-off point for repayment.

Interest rates on bridging tend to be higher than mortgages, due to the short nature and generally higher risk. However, with so much lender competition in the sector, rates are much better than they were. Borrowers can pay the interest charges monthly, but it’s more common for interest charges to be rolled up and paid at the end of the term. Unlike mortgages, approval for bridging finance is based on property value, viability of the project and a strong exit strategy, rather than borrower affordability. Therefore low income or cash-flow shortages shouldn’t prevent someone from securing funding.

What Is Development Finance?

The next question to ask is what is development finance? Generally, when developers are purchasing land or sites and constructing new residential or commercial buildings they will fund it using development finance. Lenders might specialise in either residential or commercial development finance (a pre-let or pre-sale is usually required for commercial loans).

Whether it’s ground-up construction or the conversion or refurbishment of an existing building, developers receive a funding package that is tailored to the project and building programme.  This makes development loans complex and time-consuming to arrange, so most lenders don’t consider applications under £1m, although there are options under this level, and potentially as low as £150k. Lenders favour bigger loans because it takes a similar resource to arrange a £150,000 loan as it does a £1.5m, but the loan earns them around a tenth of the return.

How much can be loaned depends on four key figures:

• Gross Development Value (GDV)
• Projected build costs
• Equity contribution
• Day-one land cap

Whilst all UK development finance lenders have different lending limitations, most will consider up to 65% of the GDV, up to 65% of the site/property purchase price and up to 100% of build costs. To fund the 35% shortfall, a developer may take a smaller, secondary loan known as mezzanine debt, or it’s also common to see borrowing from external investors

A key element of development finance is that the loan is effectively two loans. Part one contributes towards the site purchase and part two funds the construction. The second part is paid in stages, known as tranches, which is agreed from the onset to align with the developer’s build programme.

So, what is property development finance? Basically, property development finance explained in simple terms is a programme of funding to take a project with detailed planning permission from initial purchase through the build phase and onto completion.

What are they used for?

Whilst both bridging and development loans are a means of finance for property development they generally have different uses, so specifically what are they used for?

Bridging loans have a unique role in the finance market because of the short time it takes to arrange, making them the go-to loan for fast property transactions, such as;

• auction purchases, where the time period for completion is usually just 28 days
• to take advantage of market conditions, like a reduced price on land or sites
• raising money against other assets, as speed will enable you to purchase another asset at a discount

The most common use for bridging finance is for funding transitional assets; as the borrower transitions the property from one stage to another. Be that taking the project through the planning process, or taking a dilapidated property and refurbishing it until it is ready for someone to live in.

Using a bridging loan for property development is now considered a vital tool for any savvy property developer because it creates opportunities on properties that are ineligible for traditional finance.  The best examples are:

• uninhabitable properties (no working kitchen or bathroom) or where substantial works need to be done
• commercial premises that could be converted to residential (you may also use development finance for this, but it will depend on the size of the loan/project)
• buying land pre-planning

As well as property, bridging finance can be used for buying business equipment or funding tax liabilities.

The above are typical examples of commercial transactions and will normally be unregulated. Homeowners might use a property development bridging loan for a number of transactions but if you or your family live there, then it will almost certainly be a regulated bridge loan. Examples might be:

• building a new home or securing a home without selling their current one
• preventing a property chain breakdown
• funding substantial renovations.

Meanwhile, development finance can only be used to fund property development as a business venture. (Development loans can be obtained for building your own home, commonly known as self-build mortgages, but unlike development finance they are income and means tested. Therefore, the borrower needs to demonstrate their ability to repay the loan with a regular mortgage).

Crucially, development finance is used when the site has detailed planning permission or permitted development rights. Prior to planning permission being granted, a bridge loan can be used to provide the finance to purchase the asset and then converted to a development loan when planning is in place.

What is the difference between them?

There are so many factors to consider when funding property development, and choosing which type of finance to use begins with asking what is the difference between them? 

As mentioned already, bridging finance is a unique type of loan and it’s often the only option for certain property transactions. Generally, bridging loans are more accessible than development finance, and many high-street banks offer bridging loans though they often don’t advertise or provide information on their bridging products. Whilst there are online sites who compare bridging loans, they’re unlikely to return results from any of the specialist bridging loan lenders.  The surest way to find the best available bridging finance is by using an expert broker who knows and has working relationships with these lenders.

Likewise, development finance brokers are the best way to secure appropriate funding.  There are so many variables with development finance, that speaking to just one or only a handful of lenders can cost borrowers tens or hundreds of thousands of pounds in avoidable costs. Only a thorough whole-of-market search gives you the highest chance of getting the best deal - at Brickflow, our software searches more than 40 development finance lenders in minutes. Without Brickflow’s comprehensive search tool, brokers might only search and compare loans from 3 - 5 different lenders, so for brokers and developers, Brickflow is the surest way of sourcing and securing the best development finance available.

If you're a broker, register for Brickflow today and have a DIP on your desk tomorrow. If you're a developer, model your deals and check how profitable they are, or if you're ready to apply, contact Brickflow to be connected to one of the best brokers in the market.