If you’re planning to buy a property at auction, it’s vital to have the finance arranged in advance. Most auction finance takes the form of bridging loans. They are quick and easy to arrange before auction day, and cost you nothing in advance. The whole process is actually much easier than you probably think.
Remember: Property auctions are not a secret society!
This is our second article about buying property at auction. If you missed the first one, you can check it out here.
In that article, we dispelled the myth that property auctions are a mysterious or secretive world, only accessible by a select few seasoned property professionals.
The truth is, property auctions are more popular than ever before. Most property investors have watched countless episodes of Homes Under the Hammer or similar TV shows; in fact, clients often tell us that’s how they became property investors or developers in the first place.
Auctions can be a great way to buy properties quickly (there’s no chain with auction purchases), and these days almost all auctions allow online bidding, so you don’t need to leave the comfort of your desk or sofa to buy your property.
It’s true, there are a few things that are unique to auction purchases, but the whole process is actually quite straightforward and not nearly as scary as many people imagine.
Another myth we dispelled in our previous article was that auction purchases are only available to cash buyers. While some buyers do have enough cash to buy a property without using external finance, every smart property investor knows that the way to maximise the returns from their property portfolio is by using as much external finance as possible to create leverage. Why spend £200,000 cash on a single property, when you can use the money to buy two, three or even four properties by putting down a £50,000 deposit on each one and borrowing the rest?
High street banks and other mainstream lenders will generally not offer loans to buy properties for auction. It’s just not what they do. One reason for this is that auction properties may be unmortgageable, perhaps because they have been empty for a while and don’t have a kitchen or bathroom.
But the main reason mainstream banks and lenders won’t support auction purchases is timing. Auction purchases usually complete within 20 business days (this is often described as “28 days” or “4 weeks”).
And anyone who has bought or sold any property through the traditional estate agent route, knows that hardly any transactions complete within 4 weeks.
Enter the bridging loan
Bridging loans are usually short-term loans (anything from 3-24 months, but typically 6-12 months). As the name suggests, these loans “bridge” from one point in time (in this case, the auction day) to a later point in time (for example, after the property has been refurbished and sold, or perhaps refinanced with a long-term buy-to-let or other mortgage loan).
In fact, bridging loans are used in finance for all kinds of reasons. Another common place to see them used is when a property is being sold on the open market and a property developer or investor wants to buy the property quickly to avoid losing it to another buyer. Within a few days, a bridging loan can be arranged, and the buyer can secure the property.
Bridging loans – the step-by-step process
We’ll now take you through the basic steps of using bridging finance to buy a property at auction:
Step 1 – Browse the auction listings
These days there are property auctions every month, all over the UK. You can be fairly certain that there will be a property auction coming up in your area of the country within the next few weeks, virtually all year round.
You can get a good idea of what auctions are coming up across the UK, where, and through which auction house, here: https://www.propertyauctionaction.co.uk/.
As you’ll see, next month alone there are more than 50 auctions listed around the UK, and this is by no means an exhaustive list.
So find out which auctions are coming up, get yourself on the mailing lists to receive details of future auctions, and you’re in business.
Step 2 – Find properties you want to bid on
Every property investor is different: some are looking for refurbishment or conversion projects, others want buy-to-let properties. Houses in Multiple Occupation (HMOs) are particularly popular these days or properties that can be converted into HMOs.
Whatever type of property is your bag, you’re likely to find several properties coming up at auction that tick the boxes.
Step 3 – Do your research
Most properties coming up at auction will have some kind of viewing or open day, where you can go and inspect the property. If possible, take someone with you who can assess the physical and structural condition of the property. They should be able to help you identify any major problems or concerns with the property.
The auction house or their solicitors will also have a document pack available for each property, so you can check all the plans, any tenancy agreements in place, and so on. Have a solicitor review these, again to make sure everything checks out.
Step 4 – Decide your maximum bid
This sounds obvious, but it’s common to see buyers get caught up in frenzied bidding when a property is particularly popular. And always remember: the guide price you’ll see on auction listings may look attractive, but the eventual selling price will often be quite a bit higher.
Not surprisingly, properties that have a very low guide price usually attract the most interest from buyers.
So, do your research, and figure out what is the highest amount you’re willing to pay for a property. This is important not just to ensure you don’t get caught up in an auction and overpay; it’s also important because a potential lender will provide an indicative loan offer based on that figure. If you end up bidding more, there’s no guarantee the lender will be able to provide the finance you need.
Step 5 – Remember your PLEBS!
No, dear reader, we’re not trying to insult you, nor is it a grammatical error.
PLEBS is a useful mnemonic to remember what information lenders need to see, in order to be able to give you an indicative loan offer before the auction day.
Don’t panic – it’s fairly basic information, and Clear Idea can help you prepare everything, but let’s look at each one in turn to see what’s involved:
What is the loan for? Is it a straight purchase? A purchase plus work? If so, what work are you intending to carry out? Is it light refurbishment, or heavy structural work?
There are several different types of bridging loan available for different purposes, so it’s important to be as detailed as possible when telling lenders what you plan to do with the property.
How much finance do you need? 75% is usually the maximum loan-to-value ratio (LTV) for unregulated loans (those properties bought purely for investment or commercial purposes) or 70% for regulated loans (properties bought for your own personal use).
However much finance you’re looking for, it’s important to remember that you’ll still need to pay a 10% deposit on the auction day if yours is the winning bid. So always make sure you have the 10% available in cleared funds, ready to transfer straight after the auction.
When it comes to lending, the most important thing for any lender is getting repaid. So with a short-term bridging loan, how do you plan to repay the loan?
Will you refinance the loan with a long-term buy-to-let (BTL) or other mortgage loan?
Or perhaps you’re planning to refurbish the property and then sell it (known as an “auction flip”), or maybe you’ll refinance into a longer-term loan after a few months, after the work is complete.
Whatever your plans are, the lender ultimately needs to be satisfied and confident that their loan will be repaid, and when, and how.
The lender wants to know about YOU! What’s your background and experience in property investing. Are you a seasoned property investor with a large portfolio, or are you fairly new to property investing?
It’s worth stressing that bridging lenders tend to look more at the property itself and your personal (or your company’s) assets and liabilities. They’re not too concerned about your personal income, though they will want to know if you have any previous adverse credit events.
It’s not necessarily a deal-breaker if you do have any adverse credit events, but it’s always better to disclose everything upfront since lenders will find out about them when they do their usual credit searches. It’s never a good look if it appears that you’ve tried to hide something.
Finally, lenders will want to know about the property itself, since that’s clearly what’s providing the security for the loan.
What is the property? Share the link to the auction listing and any information and documents you have about the property.
If you’re planning to refurbish or otherwise alter the property, what will it look like after the work is completed? Will it be rented out? What will the rental income be? If you’re planning to sell it, what is the likely sale price, and how do you justify that figure (e.g. with market comparables)?
Getting an Indicative Loan Offer
At Clear Idea, we always advise clients to send as much of the PLEBS information to us as early as possible. In practice, most property investors identify auction properties they’re interested in a few weeks before auction day.
In fact, lenders can generally prepare an indicative loan offer within a few hours, so even if you contact us a few days before an auction, we can usually get you the financial comfort you need without any problems.
In a recent transaction, we were approached by an auction buyer the day before an auction, and we were able to secure indicative offers from two bridging lenders the same day.
Congratulations – you’ve won the auction – now what?
Once the hammer falls, you’re usually required to pay the 10% deposit on the spot. At this point, contracts have been exchanged, and you’re legally committed to complete the purchase within 20 business days (i.e. 4 weeks).
At this point, the clock is ticking, and you need to get things moving as soon as possible. Don’t leave it a few days, since every day matters, and it’s important to get the legal/conveyancing process underway without delay.
The first step is to tell us that you’ve won the auction. We’ll then get the formal process underway with the lender, which will involve sending them an application form, for formal underwriting.
Up to this point, you’ve spent no money at all, except possibly some legal fees if you had a solicitor review the auction documents before auction day.
Once the loan goes into formal underwriting, you’ll need to pay a valuation fee to the lender. As a rule of thumb, this costs around £400-600 for properties up to £500,000.
After formal underwriting, and assuming everything checks out, the lender will make a formal loan offer.
If you accept the offer, you’ll then pay the lender’s legal costs, which are typically around £1,000-1,250, depending on whether it’s an individual or company purchase, the property value, etc.).
You’ll usually also pay for your own legal costs – most lenders won’t allow dual representation by one firm of solicitors.
How much does bridging finance cost?
Bridging loans are more expensive than ‘regular’ mortgage loans, but remember, they’re only short-term. Also, it’s not possible to get a regular mortgage loan for a property bought at auction.
The term for a bridging loan is usually 6-12 months, but can go up to 24 months. There is also usually flexibility to redeem the loan early, but you’ll only pay interest for the time the loan is in place.
As a rule of thumb, bridging loans usually cost around 0.50 - 0.75% per month, again depending on the LTV, and the lender’s assessment of the “riskiness” of the loan. Remember, you’ll know this before the auction since it will be contained in the indicative loan offer.
There will usually be an arrangement fee of around 2%. Some lenders will also charge an exit fee, but we try to avoid them wherever possible.
Interest on bridging loans can seem confusing, and it’s usually treated in one of two ways:
Rolled-up interest: you pay nothing during the term of the loan, the interest ‘rolls up’ during the course of the loan, and is paid whenever the loan is repaid.
Retained interest: all the interest is deducted upfront from the loan and ‘retained’ by the lender. If you then redeem the loan prior to the agreed redemption date(e.g. you redeem after 9 months instead of 12), any ‘unused’ interest will be refunded by the lender.
Auction finance: The final word
Bridging loans, rather like property auctions, are neither complicated nor mysterious. They are particularly well-suited to auction purchases because they are flexible, quick and straightforward to put in place.
So if you’re planning to buy property at auction, get in touch with us at Clear Idea to discuss how to get the finance in place well ahead of time, and on the best possible terms.