How to finance your property development

There are a wide range of property development finance options available, from bridging loans to buy-to-let mortgages. Discover the pros and cons of these assorted options, and find out which one is right for you.

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If you want to invest in property and don’t have a load of cash lying around, then you’ll need property development finance. It’s a broad term that covers lots of different options, including various mortgages, business loans, and even unsecured personal loans. Eligibility varies widely – some lenders need a fleshed out business plan, while others will just look at your credit score – but to have the best chance of getting a good rate, you’ll need to make sure you have a well-planned investment strategy.

One thing you won’t be is short of lenders. The UK property development lending market is buoyant, and in 2018 alone, members of industry body UK Finance lent a total of £40.5 billion on buy-to-let mortgages alone (a 5.5% increase on the previous year).

However, there’s no doubt that the world of property development finance is a complex and confusing one. It’s full of jargon, and it’s often hard to work out the pros and cons of the different options on offer. Luckily, we’re here to help – read on to discover just what is meant by a bridging loan, the ins and outs of buy-to-let and buy-to-sell mortgages, and what exactly deferred interest is.

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Property development finance options

We’ll start by summarising the five main ways to finance your property development:

  • Cash – Pretty self-explanatory, this one: if you have a load of money handy, you can use it to buy property. This probably won’t be a viable option when you’re starting out, but it’s worth bearing in mind for the future.
  • Buy-to-let mortgage – If you want to buy a property and rent it out, then a standard mortgage won’t be suitable – instead, you’ll require a buy-to-let mortgage. These have key differences from a conventional mortgage: they demand a higher deposit, come with larger interest charges, operate on an interest-only basis, and attract bigger fees.
  • Buy-to-sell mortgage – You also won’t be able to use a standard mortgage if you intend to purchase a property, do it up, and then sell it again. To do this, you’ll need a buy-to-sell or flexible mortgage, as this will let you sell a property shortly after buying it – something you can’t do with a standard mortgage. As you’d expect though, you pay for the privilege in the form of significantly elevated interest rates, bigger fees, and a much heftier deposit.
  • Bridging loans – Bridging loans have a short duration and charge high interest. They are commonly taken out by people who want to buy a new home, but haven’t yet sold their existing one. In terms of property development, bridging loans are often used to buy a property, renovate it, and then sell, paying off both the interest and loan amount in the process. It’s vitally important to know that bridging loans are a form of secured loan, and so you’ll most likely need property or land that the loan can be secured against. A bridging loans lender will also demand a clear exit plan that explains how you will pay off the loan at the end of the term.
  • Property development finance – A broad term that covers both specialised loans for established property development companies and loans that cover heavy refurbishment. Acceptance and rates depend on your property development track record, and the strength of your business plan.
  • Personal loan – If you just need a bit of cash for a bit of light refurbishment, or have inherited a property that needs a little TLC, then you might want to consider taking out an unsecured personal loan.
Should I form a limited company?

It may be tempting to form a limited company to invest in property, as you’ll pay corporation tax on what you earn instead of income tax. However, as well as requiring lots of extra work, there are also financial complications, such as higher interest rates on loans and potential liability for dividend tax. There’s a lot more detail in this excellent FT Adviser piece, but the right choice for you will depend on your individual circumstances, investment plans, and tax liability.

Research conducted by independent mortgage broker Private Finance in 2017, for example, found that buying investment property through a limited company would reduce income by £1,000 for a landlord with one property. The research also found that landlords must own at least four properties to benefit from a limited company structure

As such, make sure you investigate the pros and cons carefully before making a decision.

Buy-to-let mortgages

As mentioned above, if you want to buy and rent out a property, you’ll need a buy-to-let mortgage. This is because standard residential mortgages usually have clauses that forbid you from letting the property.

What are they?

A buy-to-let (BTL) mortgage pretty much does what it says on the tin – it allows you to buy and then let out a property. One key difference from a normal mortgage is that a buy-to-let mortgage is usually offered on an interest-only basis – in other words, your repayments will only pay off the interest on the mortgage, rather than the actual amount you borrowed. At the end of the term of the loan, you’ll then need to pay back the amount you actually borrowed, either by selling the property or by taking out another mortgage on it.

For the lender, a BTL mortgage is riskier than a standard mortgage – the repayments should be covered by tenants paying rent, but this can cause problems, as can empty months when the property is vacant. Because of this, BTL mortgages have higher interest rates and charges.

As the chart below shows, you’ll also require a much bigger deposit – 25% is usually the minimum, but depending on your circumstances, you may need to stump up as much as 40% of the purchase price.

It’s easy to see these sizeable deposits as a bad thing, but there is an upside – the less you borrow, the lower your monthly repayments will be, and the less you’ll have to pay off or refinance at the end of the term.

Am I eligible for a buy-to-let mortgage?

To get a buy-to-let mortgage, you’ll need to tick the following boxes:

  • You own your home, either outright or through a mortgage
  • You have a good credit record
  • You earn at least £25,000 a year
  • You’re not too old – many lenders will have an upper age limit of 70 or 75 for how old you can be when the mortgage ends. If, for example, the term of the loan was 25 years and the age limit was 75, you’d need to be 50 or under to be eligible.
  • You will receive enough rental income – a common stipulation is that the rental income received needs to exceed your monthly repayment by 25-30%.

Need to know

There are three basic types of buy-to-let mortgage:

  • Tracker mortgage – With a tracker mortgage, the interest you pay is set at a stated percentage above the Bank of England base rate. As of January 2020, this base rate stands at 0.75% – the highest level in nine years, and a rate that hasn’t changed since 2 August 2018.However, this rate can (and historically has) moved up and down. Every time it does, the amount of interest you pay will change – you’ll pay less when it goes down, and more when it goes up. It’s vital to include this in your calculations if you’re considering a tracker mortgage.
  • Discounted variable mortgage – If you’re on a discounted variable mortgage, then the interest paid will be fixed at a certain percentage below the standard variable rate (SVR) for your lender. You should be aware, however, that your lender can raise their SVR by any amount at any time, and you have no control over this. Obviously, when the SVR goes up, the interest you pay will go up too, so make sure you bear this in mind when choosing between BTL mortgages.

Discounted rate deals usually have a term of two years – after this, you will be moved to your lender’s standard variable rate, and be able to look for another loan.

  • Fixed-rate mortgage – A fixed-rate mortgage is the most straightforward of the three. Your repayments will stay at the same level for the length of the loan –  generally two, three, five, or 10 years. At the end of the term, you will be moved to your lender’s standard variable rate, and be able to look for another loan.

With any BTL mortgage, make sure you plan for periods when you have no rent coming in. You’ll still need to make repayments, so ensure you have a buffer to cover this.

Overall, Neil Roper, regional director for UK Midlands for Assetz Capital, concludes: “Buy-to-let opportunities can provide good income, as long as the property is not overleveraged [i.e. borrowed against too heavily] and the cashflow tenant is reliable. Management of that relationship and general upkeep of the property are further considerations for this property finance method.”

Always be aware that you won’t necessarily be able to sell the property for more than you paid for it – prices can fall as well as rise, and you’ll still need to cover the difference on the loan if you make a loss.

Buy-to-sell mortgages

If you want to buy a property, do it up, and then sell it on, you’ll need a buy-to-sell or flexible mortgage. This is because a standard residential mortgage will usually impose hefty early repayment fees, and won’t allow you to sell within six months of purchase.

What are they?

A buy-to-sell mortgage has two key benefits over a standard mortgage – there are either low or no redemption fees, and no restrictions on how quickly you can sell the property.

Naturally, you pay for these privileges – these mortgages have higher interest charges and associated fees than a normal residential mortgage, and you’ll also need to contribute a larger deposit (at least 25%).

Am I eligible for a buy-to-sell mortgage?

When deciding whether to accept you for a buy-to-sell mortgage (and what terms to offer you), a lender will use the following criteria:

  • Exit route – This is the most important. A lender will want to know exactly how you plan to repay the loan, and whether your plan is achievable. This will usually involve either selling or remortgaging the property, often with refurbishment involved. To offer you a loan, a lender will need to be satisfied that your plans are realistic.
  • The property – The easier your property is to sell, the better the chance you will be offered a buy-to-sell mortgage. In particular, lenders prefer properties that are “habitable”, i.e. they have a working kitchen and bathroom.
  • Credit score – Like any loan, a lender will assess your credit score to work out whether you’re generally good at repaying debts.
  • Experience – It’s something of a catch-22, but if you can demonstrate that you have previously used a buy-to-sell mortgage to “flip” a property (buy, do up, and sell), then you’ll have a better chance of being offered another buy-to-sell mortgage on generous terms.

Need to know

Buy-to-sell mortgages are most suitable for experienced property developers, as you’ll need to demonstrate you know what you’re doing and have a solid business plan.

Luke Egan, Head of Specialist Property finance at Pure Commercial Finance, adds: “In most cases, buy-to-sell borrowers will look to purchase a property and make quick-win improvements in order to ‘flip’ and sell the property at a profit. This sale will then repay the loan. Using this form of finance often involves purchasing at auction, or picking up properties below market value which are uninhabitable and ‘scary’ to the average residential buyer.

“Although the application process will be similar to if you were buying a new home, there will be fewer lenders to choose from, and you will be charged more for the ‘flexibility’ in the form of higher interest rates and a bigger deposit.”

Bridging loans

A bridging loan is a short-term loan with a high rate of interest. They are commonly used by people who want to buy a property before they’ve sold their existing one, but are also popular among property developers that want to buy, renovate, and sell properties (especially if the property requires extensive renovation, and therefore isn’t suitable for a buy-to-sell mortgage).

What are they?

Bridging loans are not mortgages – they are high-interest loans that can be theoretically used for any purpose. They are quick to arrange, and therefore particularly suitable for buying dilapidated properties at auction, when the full amount must be paid within 28 days of the sale. They come in two forms:

  • Closed bridging loans – With a closed bridging loan, you’ll need to tell the lender when and how you will pay off the loan (an exit plan). You’ll therefore need a solid strategy, and usually be able to settle the balance within a few months.
  • Open bridging loans – As the name implies, with an open bridging loan, you won’t need to pay the money back by a certain date, and therefore don’t need to provide an exit plan. You’ll usually pay a higher rate of interest than with a closed bridging loan, and they typically last for one year (although longer term bridging loans are also available).

When you apply for a bridging loan, you’ll usually receive a decision within 24 hours. If you’re accepted, you’ll have the money in approximately two weeks. This makes them great for urgent purchases, as long as you can afford the high interest rates.

Am I eligible for a bridging loan?

Lenders will make bridging loan decisions based on the following factors:

  • Security property – A bridging loan usually needs to be secured against a property, and some lenders may even require you to already own more than one property.
  • Proof of income – This isn’t always required, but you may get a better rate if you can demonstrate that you have a steady income coming in.
  • Business plan – Depending on the loan, you may need to satisfy your lender that you have a clear commercial strategy in place.
  • Property track record – Lenders will always be more likely to grant a property development bridging loan to applicants that have previous success in property development projects.

Need to know

With a bridging loan, interest is paid in one of two ways:

  • Monthly – The interest is paid separately to the loan every month.
  • Rolled-up – The interest is deferred, and paid in full along with the loan amount at the end of the term.

Property development finance

Property development finance is a broad term that means different things to different lenders. The most common interpretation is that it covers either heavy refurbishment, change of use, or ground-up development (i.e. building from scratch).

This type of lending is targeted at experienced developers, and certain lenders may only accept applications from companies rather than individuals.

What is it?

Of all the finance options discussed here, property development finance is the most specialised, and likely to involve the largest lending amounts. You’ll likely have a solid track record in property development, and be planning development activity that’s not covered by any of the other finance options discussed on this page. Most lenders will consider loans on a case by case basis, and set interest rates accordingly.

Am I eligible for property development finance?

There are two key factors that underpin acceptance for property development finance:

  • Your property development history – Your lender will need to be satisfied that you can pull off your plans; the success of your previous projects will be key in this regard.
  • Your business plan – Expect your lender to go through your business plan with a fine tooth comb – you’ll need to demonstrate that you know exactly what you’re doing at each stage of the project.

Need to know

Of all the finance options discussed here, property development finance is the most specialised, and acceptance rates therefore tend to be low. Always consider whether your needs could be met with another finance method, and only apply if you have the track record and skills for a comprehensive redevelopment project.

Personal loan

If you already own the property and just need some cash for a bit of light refurbishment, then the easiest option might be to take out a personal loan. Depending on the lender, you can borrow between £1,000 and £50,000 for between one and eight years.

What is it?

A personal loan is usually unsecured – in other words, you don’t offer up a specific asset like a car or property that can be taken by the lender if you don’t pay back your loan. Your lender will still try to recover assets if you fail to pay, but the lack of an explicit relationship between the loan and a particular asset means interest rates can be higher, and that your credit score is crucial.

Am I eligible for a personal loan?

Acceptance and rates for personal loans depend on the following criteria:

  • Credit score – Your credit score gives a lender a good idea of your financial history, as it shows how good you’ve been at repaying previous debt, such as credit card repayments.
  • Income – Having a steady job will help persuade your lender that you’ll be able to make the loan repayments.
  • The electoral register – This is a record of everyone who is registered to vote in the UK, and is used by lenders to check your identity. If you’re not on the register, your application may therefore be refused. Adding yourself is easy, though – simply go to the official register to vote page and fill in your details.

Need to know  

Most high street banks offer personal loans, but you may need to already be an existing customer to be eligible or offered the best rates. Regardless, this is a competitive market, so make sure you check out a few different options before choosing a lender.

Final thoughts

By now, you should have a good understanding of the different property development finance options available, and the pros and cons of each. The right option for your project will depend on your personal circumstances and development objectives, so make sure you have a good idea of what you want to do, how much it will cost, and how long it will take before making any concrete finance decisions – after all, there’s nothing worse than a costly debt you’re not able to repay.

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Alec is Startups’ resident expert on politics and finance. He’s provided live updates on the budget, written guides on investing and property development, and demystified topics like corporation tax, accounting software, and invoice discounting. Before joining, he worked in the media for over a decade, conducting media analysis at Kantar Media and YouGov, and writing a wide variety of freelance pieces.
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