Bridge Loans: A Simple, Affordable Way to Bridge the Gap to Long-Term Financing
Also, known as gap financing, interim financing and swing loans, bridge loans feature a variety of names.
As a popular form of short-term financing, consumers and businesses use bridge loan lenders to help obtain funding quickly while waiting for long-term financing or the sale of property.
Curious how commercial bridge loans work? This guide will tell you everything you need to know!
Let’s get started…
Table of Contents
- What is a Bridge Loan?
- Common Business Uses for Bridge Loans
- Bridge Loans for Real Estate
- How Does Bridge Loan Financing Differ from Traditional Loans?
- An Example of Bridge Loans in Action
- What are Some Common Bridge Loan Requirements?
- Things to Consider Before Choosing a Bridge Loan
- Finding the Best Bridge Loan Lender
What is a Bridge Loan?
Investopedia defines them as follows:
“A bridge loan is a short-term loan used until a person or company secures permanent financing or removes an existing obligation. This type of financing allows the user to meet current obligations by providing immediate cash flow.”
In most cases, bridge loans are used as an interim solution while other funding is raised and secured.
Typically, property is collateralized to cover the loan. Once long-term funding is established, or the property sells, you can use the new funds to pay off the bridge loan.
Key Aspects of Bridge Loans:
- Collateral: Existing commercial or non-owner occupied residential property
- Term: Typically, 6 to 12 months, though some extend up to 3 years
- Interest: Approximately 2% above current prime rates
- Equity requirements: Varies based on bridge loan structure. Most require at least 20% equity in the collateralized property.
- Prepayment penalties: Good bridge loans won’t include prepayment penalties.
In some cases, monthly payments won’t start for a few months after the start of the bridge loan. If the property sells or permanent financing comes through quickly, you might never make a monthly payment at all!
Common Business Uses for Bridge Loans
In most cases, commercial bridge loans are used to buy commercial properties when permanent financing is not yet available.
Scenarios might include:
- The property you wish to purchase needs significant renovation to meet financing requirements
- Your current credit profile prevents traditional financing
- The property has poor occupancy rates
- Complete ownership of the property is not yet in place
- You need to close quickly and cannot wait for approval on permanent financing
- Businesses also use bridge loans to stabilize finances while additional funding is sourced or secured.
Uses within major industries include:
- Hospitality: Stabilizing cash flow or securing funding for renovations and improvements
- Retail: Securing new locations while waiting for sale of existing location to close
- Industrial: Renovations and improvements to a building space
- Office: Transitioning between spaces
- Multifamily: Renovations that improve property value and income potential
- Business: To stabilize cash flow between rounds of funding, to help distressed businesses stabilize while sourcing investors or to stabilize finances while negotiating an acquisition.
As interim financing is often limited to a year, it’s an ideal source of rapid, short-term cash injections for businesses.
Bridge Loans for Real Estate
Consumers might also find value in bridge loans.
Often, when selling a home or property in a slow market, finding a buyer takes time.
If you’re relocating for work or already have a new home or property lined up, bridge financing real estate offers a way to get money toward down payments or close on a new property while waiting for the original property to sell.
Terms will vary based upon your credit, equity and the structure of your bridge loan. Sometimes, you might carry two mortgages at once.
Also, should the original property not sell, you might face foreclosure on the original property.
However, with proper understanding of the risks and guidance from an experienced broker or lender, bridge loans offer a straightforward way to transition between properties at an affordable rate.
How Does Bridge Loan Financing Differ from Traditional Loans?
You won’t find bridge loans at many banks. Instead, they’re offered by private investors and lenders.
While they work much like any short loan you’d take out from your local bank, they differ in a few important ways.
- Faster approval: Since bridge loans are subject to fewer regulations and decisions are made by private lenders and investors, the approval process is often shorter than that of traditional loans. Most times, you can move from application to approval in as little as two weeks.
- Secured by property: While many traditional loans used creditworthiness as a decision point, bridge loans are secured based on the value of the property used as collateral. In scenarios, such as fix and flips or property renovations, some lenders will base terms on the improved value of the property.
- Shorter terms: Most bridge loans feature a term of 12 months or lower. Some lenders might offer extensions. However, this often results in increased costs and fees. If you cannot repay the loan when it comes due and extensions are not available, lenders may foreclose on the collateralized property.
- Higher costs: Due to the increased risk shouldered by lenders, rates and fees for bridge loans are often higher than a traditional long-term loan. Interest rates sit at around 2% above prime rates. Origination and closing fees are often higher as well.
- Typically due upon sale of existing property or financing approval: Most gap financing agreements include a due-on-sale clause. This means that once the property used to collateralize the loan is sold, the lender can call the loan due. If you are not selling the property, the loan may come due once permanent financing is secure.
Bridge loans also do not require the majority of the property to be used for business operation. This makes them an excellent alternative to SBA 7a and CDC/SBA 504 loans if you work with commercial investment properties or income-producing properties.
An Example of Bridge Loans in Action
Let’s create a hypothetical apartment complex under contract for $10-million. On the hunt for a bridge loan, Asheville, NC, real estate mogul Robert Mountains is checking out the new property.
While it’s in a fantastic location, the building is less-than-perfect and a little dated. It’s running at a vacancy rate of 40-percent.
Through research into surrounding properties and due diligence, he determines that the property value could more than double to $22 million with only $3 million in renovations and improvements.
Here, a hard money bridge loan for $13 million provides the capital to obtain the property and perform renovations.
Once the project is complete, he both raises rent and improves occupancy. At the 90% occupancy mark, he refinances with a traditional commercial mortgage loan at the estimated $22 value and eliminates the bridge loan.
What are some Common Bridge Loan Requirements?
Because bridge loans are less regulated than other types of commercial financing, requirements and terms vary from lender to lender.
However, these guidelines are a good starting point for ensuring fast approval and good terms:
- A Debt Service Coverage Ratio (DSCR) of 1.1 to 1.25
- A credit score of at least 650
- Net worth equal to or greater than the loan amount requested
- Prior experience and success with projects like the one you’re attempting to finance
- Financial documentation on all principals and applicants
- A breakdown of costs the loan will fund
- An action plan and executive summary
These requirements allow the lender to assess risk and ensure that you’ll be able to meet the terms of the loan. While most bridge loans require property that the lender can sell in the event of default, most would prefer to see you happy and collect their fees without this hassle or your misfortune.
Things to Consider before Securing a Bridge Loan
While bridge loans offer outstanding value for the right needs, they’re not for every situation. Before you use a bridge loan for your next investment project or business need, consider these points.
- Bridge Loans Offer Speed and Flexibility at a Price: In many cases, if a traditional financing agreement will meet your needs, you’ll pay less going that route. However, for many, the increased approval speed and flexible terms make interim financing an attractive and effective solution.
- Creditworthiness is Key: While some structure finance solutions, such as hard money loans, are easy to obtain with less-than-perfect credit, your creditworthiness is more likely to impact the decision for a bridge loan. This is particularly true if you’re using the loan to obtain a new property while still holding a property you’re attempting to sell.
- Evaluate Terms and Don’t Be Afraid to Get Multiple Offers: Since bridge loans face fewer regulations and approval requirements vary, you’ll find a range of costs, terms and requirements associated with offers. Shopping around or using a reputable broker or lender is essential to finding the best gap financing for your needs.
- Perform Due Diligence and Ensure that You Are Prepared if Your Existing Property Doesn’t Sell: Should your property sell slower than expected, you might find yourself making two loan payments until the sale closes. Be sure to assess your financial capabilities to avoid stress later. Most experts recommend the ability to make both payments for at least 6 months to reduce the risk of foreclosure or other undesirable outcomes.
- Don’t Forget the Fees when Deciding Interim Financing Amounts: While a bridge loan is ideal for transitioning between properties, kick-starting your next investment project or stabilizing a business situation while funds are pending, be sure there is enough left after covering the initial debt and loan fees to cover any expenses until the sale closes. If not, you might be left unable to find additional funding but also unable to move forward with the project or new property.
Finding the Best Bridge Loan Lender
As mentioned above, due to decreased regulations, bridge loan terms and rates vary from lender to lender. While you could spend, the time searching for lenders, gathering referrals from friends and colleagues or researching on the Internet, a good broker takes the hassle out of both finding and comparing bridge loan offers.
UT Financial Services, LLC, helps businesses looking for bridge loans or gap financing using real estate as collateral. With more than 20 years of experience and an extensive network of private investors, lender relationships and access to institution capital, we’ll help you find the perfect structured financial solution to meet your business needs.
Call us to schedule your initial consultation or leave your contact information in the form below. One of our analysts will reach out to discuss your needs and business situation. You could have funding for your next project in as little as two weeks!
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