It’s not unusual for property professionals of all types to find themselves in emergency situations requiring a quick financial fix. Likewise, when a promising opportunity appears suddenly on the market, it can be extremely useful to have a short-term funding option at hand to enable you to make the most of it.
But do you know your bridging loan from your Second Charge mortgage? Can development finance cover a sudden shortfall? And what could possibly go wrong if you’re relying on a ‘common-or-garden’ business overdraft? Here, we’ll go over the pros and cons of the various short-term finance options open to property developers and investors. At the end of it, you should have a clearer idea of the type of funding that will best meet your needs.
When to seek short-term finance
Construction and refurbishment snags are a fact of life; third parties can let you down, and delays in releasing cash from elsewhere can put your immediate project plans at risk.
Here are some common scenarios where short-term finance is required:
- Bridging: frequently, the purchase of one property is dependent on the release of capital from another. Where the purchase needs to proceed shortly before the linked sale is finalised, temporary finance may be required to bridge the gap.
- To fund construction/renovation costs: institutional lenders may require that the property must meet a certain level of spec before longer-term finance can be agreed. A temporary measure may be required to fund the work necessary to meet these conditions.
- Unforeseen costs and liabilities: a combination of snags may mean that your previously allocated budget may be insufficient to get the project over the line. You may need to borrow an additional injection of cash, to be repaid upon sale of the property, or once it starts to generate rental income.
When these types of cash issues arise, the quicker you can resolve them, the less chance there is of any further delays or complications. With this in mind, here are the options you might want to consider...
Borrowing from your personal funds
This is the classic ‘raiding the piggy bank’ scenario, involving the transferal of personal savings to meet the immediate needs of your property business.
Where funds are available, this may seem like the easiest and most obvious way to solve a short-term problem — and it avoids having to rely on external sources of funding.
Bear in mind, however, that if you’re trading under a limited company structure, the process is not quite as simple as transferring money from one account to another. To ensure that it’s treated correctly for tax purposes, you will need to formalise the transaction (most likely as a director’s loan).
It’s also important to be aware that “borrowing” funds from tax-efficient investment vehicles (e.g. pensions and ISAs) may mean losing some of the tax advantages you might have built up. Even if it is possible in theory to arrange a transferral from your personal funds, it’s not always the best or most cost-effective option.
Beyond personal funds, when property professionals require finance, it’s natural to turn to the bank as a first option. That said, more than half of smaller firms cite an inability to source funding as the most significant challenge faced by their business. It suggests that traditional sources of funding — banks in particular — are slow to meet the needs of businesses.
If you have a strong existing relationship with your bank and they are already familiar with your business model, this can greatly increase the chances of a relatively swift loan approval. On the other hand, if this is a first-time application for finance, the bank will almost certainly need to conduct thorough eligibility and due diligence checks. Even if you get a positive decision at the end of it, just be aware that the often drawn-out nature of the approvals process can make it difficult to rely on a bank if you need short-term finance in a hurry.
Using your business credit card or overdraft facility
This can be a viable option if the amount you need is relatively small (i.e. within the maximum limit of your credit card or overdraft). To rely on it, you also need to be sure that you will be able to repay the debt quickly, otherwise the cumulative effect of high-interest rates will mean that you could end up paying a lot more than you would through alternative methods.
Second charge mortgages
If you already have a mortgage in place, one option for finance involves extending the amount you borrow under that loan (i.e. first charge remortgaging). The problem, though, is that remortgaging isn’t always practical for many borrowers. For instance, your circumstances might have changed since your initial application for finance, meaning that you may find it hard to pass the lender’s affordability test - or rearranging the current loan may mean being hit with a much higher rate of interest for the entire loan, or large early repayment charges.
In these circumstances, a second charge mortgage is a useful alternative; basically a second loan from a different lender that sits on top of your current mortgage. It can be especially valuable for buy-to-let landlords. For instance, you could take a second charge loan to release some of the equity from a current rental investment property and use it to fund the purchase or renovation of a further property.
Development and refurbishment finance
Banks don’t always fully understand the needs of property professionals, so agreeing on funding from a traditional lender can be a drawn-out headache.
Development finance can offer a much more accommodating alternative, and it can be suitable for new builds, conversion and refurbishment alike. If you need to alter the terms of your agreement to meet new, short-term requirements, a tailored, personalised approach means that (depending on the circumstances) your needs are much more likely to be met compared to the often rather inflexible approach taken by banks.
Originally devised to provide buyers with stop-gap finance to fund their purchase, bridging finance is a form of short-term, interest-only lending that can actually be used in a wide range of circumstances.
For instance, you might need a cash injection to meet a previously unforeseen need to purchase additional equipment or hire extra labour, or to fund an auction deposit until such time as more permanent finance can be put into place. With an ‘open-bridge’ borrowing arrangement, there is a cut-off point by which the loan will need to be repaid (usually a year), but crucially, there is no penalty for early repayment. And with minimum borrowing amounts as low as £30,000 with no set maximum, it’s both flexible and capable of being tailored to your exact needs.
Navigating the property industry can be a challenge. If you’re interested in learning more about how to make the most out of your property opportunities, head over to our blog or speak to West One today.