4 Considerations Investors Should Have Before Using a Bridge Loan
Bridge loans can be an incredibly helpful tool for multifamily investors, providing quick access to short-term capital when needed — but here are four important things to consider before using one.
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Bridge loans can be a helpful tool in certain situations, but it's important to understand how they work and what the potential risks are before using one. Here are four key considerations commercial real estate investors should keep in mind before using bridge financing:
How Are Bridge Loans Typically Used?
Bridge loans are a type of short-term debt instrument that can be used to finance the purchase or rehabilitation of a property before the borrower secures long-term financing. Because of how quickly they can be closed and funded, bridge loans are often used when a borrower is expecting to sell their property within a few years and needs financing for a new purchase in the meantime.
The key feature of a bridge loan is that it allows the borrower to close on a new property quickly. Being able to secure a property without having to wait for the sale of a currently owned property can be a huge advantage for an investor. These loans can also be helpful if you're looking to buy a property before it goes on the market, or really in any scenario where timing is critical.
Another key feature of bridge loans is that they are typically interest-only loans. This means that only the interest on the loan is paid over the duration of the loan term. This can be incredibly useful when the cash flow is tight and conserving capital is of great importance. Still, the idea is to secure permanent financing before having to deal with a balloon payment when the bridge loan matures.
What Are the Risks of Using a Bridge Loan?
A significant risk of using a bridge loan is that an investor could end up owning two properties if the currently owned property doesn't sell as quickly as planned. This could leave an investor with two commercial mortgages to pay, which could be an immense strain on finances if not avoided.
Another risk worth noting is that bridge loans typically have higher interest rates than traditional mortgages. This is because they are considered to be higher-risk loans. If an investor can’t secure a permanent financing solution and pay off the loan in a timely manner, they could end up paying a lot in interest.
Lastly, bridge loans are typically shorter-term loans, which means the loan is meant to be paid off relatively quickly. This could be a problem if a replacement loan isn’t secured, or if other financial issues occur during the loan term.
How Do You Qualify for a Bridge Loan?
The specific eligibility requirements for obtaining bridge financing typically vary depending on the lender, but getting a bridge loan is more or less the same as obtaining any other kind of commercial financing. Much of the same documentation is required (financial statements, rent rolls, schedule of real estate, income and expense statements on the subject property, etc.) — but in most cases, it is the financials of the target property that are of the highest importance to the lender.
Investors should also note that the amount of funding a borrower is eligible to receive is typically determined by a combination of factors including property value, cash flow of the subject property, and the borrower’s net worth. An investor should be able to provide the lender with this information.
Alternatives to Bridge Financing
Hard money loans are a type of short-term financing typically used by investors to purchase and renovate properties. Hard money financing often has higher interest rates than traditional loans, but they can be easier to qualify for. Hard money lenders also tend to be more flexible when it comes to loan terms, putting them on more or less equal footing with their bridge counterparts.
Private money loans are another good option for short-term financing. These loans are typically provided by individuals, rather than banks or other financial institutions. Private money loans tend to have higher interest rates than traditional loans, but they can be much easier to qualify for.
Mezzanine financing is a type of debt vehicle that is typically used to finance the purchase or renovation of commercial real estate. A mezzanine loan is a form of debt financing, structured to increase leverage on an asset through the insertion of a layer of debt between the first mortgage loan and the owner’s equity. This type of financing typically has a higher interest rate than traditional loans, but it can be easier to qualify for.
Final Thoughts
No matter what financing option you choose for your next multifamily investment, be sure to do your research and understand the terms of the loan before signing anything. Bridge loans can be a helpful tool for commercial real estate investors, providing quick access to short-term capital when needed — but there are some important caveats to consider before using one. It is always best to make sure that obtaining bridge financing is the best option for the deal when compared to its alternatives and to have a solid strategy in place to either sell the property before the bridge loan matures or to replace the debt with longer-term financing.
Related Questions
What are the advantages of using a bridge loan for commercial real estate investments?
Bridge loans are among the fastest-closing financing packages available to commercial real estate borrowers. A loan can close in a matter of days, which can enable an investor to execute her or his real estate strategy quickly and effectively.
Bridge loans can be used for a number of reasons, such as buying an office building with significant vacancy, renovating a building, or executing a purchase quickly. Bridge financing can give you access to capital, which you can then use to boost your property's value — which in turn will let you access far better, longer-term financing when the time comes.
The advantages of using a bridge loan for commercial real estate investments include fast funding, access to capital, and the ability to execute a purchase quickly.
What are the risks associated with bridge loans?
The risks associated with bridge loans include owning two properties if the currently owned property doesn't sell as quickly as planned, higher interest rates than traditional mortgages, and shorter-term loans which could be a problem if a replacement loan isn’t secured or if other financial issues occur during the loan term. Bridge loans also have higher interest rates and fees of up to 2% of the loan amount. Source 1 and Source 2.
What are the qualifications for obtaining a bridge loan?
The specific eligibility requirements for obtaining bridge financing typically vary depending on the lender, but getting a bridge loan is more or less the same as obtaining any other kind of commercial financing. Much of the same documentation is required (financial statements, rent rolls, schedule of real estate, income and expense statements on the subject property, etc.) — but in most cases, it is the financials of the target property that are of the highest importance to the lender.
Investors should also note that the amount of funding a borrower is eligible to receive is typically determined by a combination of factors including property value, cash flow of the subject property, and the borrower’s net worth. An investor should be able to provide the lender with this information.
Metrics such as debt service coverage ratio (DSCR) and loan-to-value (LTV) or loan-to-cost (LTC) still come into play, with some lenders even setting expectations for cash reserves and even borrower experience. The amount of funding a borrower is eligible to receive is mostly determined by a combination of various factors including property value, cash flow of the subject property, and the borrower’s net worth. The lender will typically loan between 65% and 80% of the LTC and 80% of the LTV of the finished value of the property.
What are the typical terms of a bridge loan?
Bridge loans are typically short-term loans with terms ranging from 2 weeks to 1 year. Most borrowers offer loan terms between 12 and 24 months. LTV/Leverage is typically up to 70%. Lender fees typically include a $500 typical appraisal fee and other fees between 1.00 - 2.00%. Closing costs are typically between 1.00 - 5.00%. These loans can typically close in as little as 15 days.
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What are the costs associated with bridge loans?
Bridge loans have higher interest rates — often significantly higher than rates on longer-term financing. This means that monthly payments could get costly, even despite being interest only. Beyond that, bridge financing also may have fees of up to 2% of the loan amount. This isn't too out of the ordinary for a commercial mortgage, and this fee can often be negotiated. Additionally, borrowers must typically have at least 20% equity in the initial property.
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What are the alternatives to bridge loans for commercial real estate investments?
The primary alternative to bridge loans for commercial real estate investments is traditional, permanent financing. Permanent financing typically has a longer term than bridge loans, and is often more cost-effective. Permanent financing can be obtained through banks, credit unions, and other lenders. Additionally, investors may consider seller financing, hard money loans, or mezzanine financing as alternatives to bridge loans.
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