Refurbishment Finance: Borrowing options for investors

Property refurbishment loans are a form of short-term financing typically used by investors and landlords to refurbish, convert or build residential properties or commercial premises. Loans are generally taken out with the aim of increasing a property’s value until it is sold on the open market or refinanced with a mortgage.

Anyone can refurbish a property and apply for a refurbishment loan, but the type of financing available depends on what the funds are for and the type and level of refurbishment being undertaken.

Types of refurbishment finance

Refurbishment finance comes in many different forms, but one of the most popular types of property development finance is a refurbishment finance bridging loan.

A bridging loan is a type of short-term property finance that allows investors to raise funds quickly to bring a property up to a saleable standard or to buy a property deemed unmortgageable at auction.

Unlike traditional longer-term mortgages, bridging loans run for a maximum period of between six and 24 months. They are designed to be a short-term fix to “bridge” the gap until a more long-term financing solution can be found.

Larger and more extensive property development such as ground up builds or large-scale developments and conversions fall under the remit of development finance. Development finance covers a broad spectrum of financing, including bridging loans, mortgages and mezzanine finance, which is a combination of loans and equity.

These projects usually require substantially larger loan amounts and can often reach into several million pounds. They also tend to have longer terms of up to 36 months and the funds are released gradually via a construction loan draw down agreement that is signed off in stages as the work progresses.

Anyone applying for a refurbishment loan is expected to provide the lender with an “exit” strategy which explains how the loan will be repaid at the end of the term. This is usually when an investor or property developer remortgages on to a traditional BTL mortgage or repays the loan by selling the property.

Light refurbishment loans

Refurbishment finance can be used for all types of property renovation and is often categorised as “light” or “heavy”. Light refurbishment tends to refer to minor renovations or updates such as painting and decorating, new flooring or installing a new bathroom or kitchen.

They are often used by buy-to-let (BTL) landlords or investors in situations where they need to move quickly because they have spotted an excellent investment opportunity and need funds to buy a property because they are facing a tight deadline.

They can also be used to renovate a property and make it more appealing to potential buyers or future tenants. This could include using the funds to make the property more energy efficient to meet the incoming energy performance certificate regulations or converting a property into an HMO if only light works are required.

Often, a light refurbishment loan will be for a smaller finance amount than a full refurbishment loan, as the renovations are less extensive and do not need planning permission or building regulation checks. In most cases, the intended use of the property will also remain the same.

Heavy refurbishment loans

Heavy refurbishment loans or development finance, is generally taken out by experienced property developers and often used for significant structural changes such as the construction, conversion or the heavy refurbishment of a property or building.

This can include ground up developments, substantial renovations that increase the footprint of a property such as an extension, basement dig or loft conversion or changing the use of a property from commercial premises to residential.

In the majority of cases, heavy refurbishment typically requires planning permission or building regulation checks and will cost more than 15% of the property’s value. Financing usually comes in two parts with the first element of funding used to purchase a development site and the second stage of the loan used to pay for the cost of the works.

Often, lenders will also need some proof of property refurbishment experience. They will also want to check the list of works, timing schedule and costings associated with the project before releasing the funds.

The maximum gross development value of these projects is often around 70%, and the loan to value is calculated on the estimated value of the property on completion. Borrowing for the development work itself is typically 85% to 90% of the total value of the cost of development and some lenders will also fund 100% of the work needed.

Buying at auction

A refurbishment finance bridging loan can also be used when buying a property at auction as the turnaround time for completion is usually much shorter than the average property purchase.

Successful auction bidders are required to put down an initial deposit on the day of auction, typically around 10% of the purchase price, with the remainder of the agreed price needing to be paid between 14 and 28 days after the auction.

As arranging a regular mortgage in such a short timeframe is almost impossible, many successful bidders will opt for an auction financing bridging loan instead as the funds can be in place within a matter of days, comfortably allowing them to meet the purchase deadline.

Auction finance bridging loans are also a good choice when buying at auction because it is common for these properties to be sold in a poor state of repair or lacking a bathroom or kitchen.

These problems may mean that a regular mortgage lender is unwilling to lend against the property at all, irrespective of any purchase deadlines. This is not an issue with auction finance bridging loans as lenders are generally comfortable offering funds against properties in need of some level of refurbishment.

Costs of refurbishment loans

Due to the short-term nature of refurbishment finance loans, the interest rates are often higher than standard mortgages. This means the costs can quickly mount up if the loan is kept in place for a long time or the project faces challenges or falls into difficulty.

It is therefore important for the borrower to ensure they have a clear exit strategy in place that will allow them to refinance or exit the loan before costs escalate. Interest rates will also depend on whether the borrower plans to hold onto the property after refurbishment or sell it once the work is complete.

Lending criteria for refurbishment finance varies between lenders, but in the majority of cases the borrower must have equity in the property which cannot be their primary residence. Loans are subject to a full valuation and all mortgage repayments must be up-to-date. Costings, pricing and a full exit strategy must also be provided.

Obtaining refurbishment finance

Refurbishment finance is an extremely complex area of the mortgage market. No two projects are the same and as a result, you are unlikely to see the products available on the high street.

This does not mean that borrowers cannot access a refurbishment finance loan when they need one, but it does mean they need to ensure they look for a specialist lender who deals with this type of financing when searching for a loan.

In some cases, light refurbishment bridging loans can be obtained directly by borrowers from a lender, but given the individual and complex nature of most cases, particularly large-scale developments, many lenders will only offer their products through mortgage brokers.

They will also always require a detailed plan of the proposed project, proof that it can be completed and evidence that the loan can be serviced before any agreement can take place.