Bridge loans help investors close real estate deals
Key features of bridge loans
- Typically secured by the property to be purchased
- Short-term, between six months and three years
- Eligibility based on the after-repair value of the property
- Higher interest rates than conventional loans
Timing is everything to investors. Whether your deal is lucrative or a let-down depends greatly on when you buy or sell an asset. This is no different for real estate investment. What happens, then, when you find a great deal on a property but can’t obtain the financing to close it? For many investors, the answer is a bridge loan.
Also known as interim, gap or swing financing, bridge loans are short-term secured loans that can be closed quickly, allowing borrowers to purchase property in a short period of time. They are often refinanced into a longer-term commercial mortgage after the real estate has been acquired.
Bridge loan eligibility is determined primarily by the property securing the loan. With residential bridge loans, a borrower’s existing property secures the loan used to purchase new real estate, and that money is used as the down payment on the purchase. With commercial bridge loans, the value of the property to be purchased acts as the collateral. Moreover, bridge loan lenders look at the after-repair value of a property when extending financing — that is, the potential value of the real estate after renovation work is completed. They will also assess the debt service coverage ratio of the property — whether yearly net operating income is enough to cover the cost of the loan.
While individual credit scores do not play as significant a role in bridge loan eligibility, there are certain qualifications that lenders may look for, including previous experience with similar real estate projects, as well as individual net worth and sufficient cash reserves.
Bridge loan rates and terms
Bridge loans are meant to act as interim financing between a real estate purchase and a long-term mortgage. As such, they are typically short-term loans, from six months up to three years.
Bridge loan lenders usually offer financing of 65 to 80 percent of the real estate’s after-repair value. Specific amounts depend on the property in question and the borrower’s debt-to-income ratio.
Bridge loans carry higher interest rates than conventional commercial real estate loans. Oftentimes borrowers can defer bridge loan payments for several months or are only required to make interest payments until the loan matures.
Why use a bridge loan?
There are two primary reasons to seek a bridge loan: time and eligibility. Closing a conventional commercial real estate loan can take several months, time that many investors can’t afford to lose — particularly when buying in a hot market. As a bridge loan can be obtained in just a few days, investors can close on a property that someone else would have acquired.
Sometimes investors are not eligible for financing due to their credit scores or the condition of the property, which can disqualify them from a conventional commercial loan. Bridge loans are particularly useful in this context as they are easy to obtain and there are no restrictions to how they can be used. For example, bridge loans can be utilized to acquire non-owner occupied real estate, renovate a property in disrepair or purchase commercial property with an occupancy rate that does not meet long-term commercial financing requirements.
Bridge loan vs hard money
Bridge loans are not necessarily hard money loans but you may hear the terms used interchangeably due to some similarities. Both are short-term financing solutions secured by property and are relatively quick to obtain. They allow for flexible repayment such as interest-only payments until maturation and no prepayment penalties, but often carry higher interest rates than conventional loans.
Bridge loans are specifically used to acquire property, while hard money loans can be used for any kind of purchase. The key difference between the two are the lenders. Commercial banks can issue bridge loans, while hard money lenders are always private investors.