What Are Bridge Loans?
09 08 2017
For many who hold commercial real estate in their investment portfolios, the nuances of the different types of financing available to them are clear as day. There are often multiple types of real estate funding that appropriately any real estate opportunity you may come across; however, they’re not all as well-known as traditional commercial mortgages from a bank.
Case in point: bridge loans.
Bridge loans play an invaluable role in the health and growth of certain segments of the real estate markets, but they’re often misunderstood or neglected entirely. Today we’ll be taking a few minutes to dive into bridge loans, their applications, and how real estate investors typically utilize them to realize their financial goals.
How Bridge Loans Are Used
Conventional lenders maintain higher levels of underwriting standards which often disqualify these scenarios from financing, so many real estate lending scenarios would suffer without the support of the bridge loans market. For multi-family and commercial properties, bridge loans provide borrowers a “bridge” to many goals: closing a sales transaction for a property, preparing a property to be eligible for a long-term permanent loan, or preparing a property for eventual sale. These types of loans are synonymously referred to as interim financing, gap financing, caveat loans or swing loans in most financial circles.
How Do Bridge Loans Work?
Bridge loans can be used to provide borrowers with needed capital to navigate a financial transition, as well as time to improve upon a property’s standing or stabilize a property. They’re relatively simple. A borrower applies for (and receives) a bridge loan. After long-term permanent financing is available for the property, the monies from the new loan are used to pay off the interim financing. In the case of a sale, the sales proceeds are used to pay off the bridge loan. Any equity cash-out or profit from a sale, belongs to the property owner. In some instances, where time and other financial constraints exist, bridge loans are put in place between the end of one loan and the start of a new one.
Bridge loans are short term loans that normally hold a first lien position against a property. They’re typically arranged for a period as short as 2 weeks and up to three years, with most taking from 6 months to 2 years. For the most part, bridge loans have interest-only payments for the duration of the loan term, ending with a balloon-payoff feature when the entire loan must be paid off in full. These loans can be serviced by conventional lenders, private lenders, or hard money lenders.
Bridge Loan Lenders
Gap financing lenders assume a higher level of risk when issuing a commercial bridge loan to a borrower due to a variety of reasons. The collateral may not be properly performing or need rehab or construction; the property, borrower, or special circumstances may fall outside the immediate lending guidelines or preferences of traditional financing. Due to this higher risk, bridge loans typically involve higher interest rates than standard loans. On a case-by-case basis, a borrower can expect additional up-front costs as well. Bridge loans certainly aren’t the best fit for every situation, but they can be effective tools under specific conditions, making them a popular form of temporary financing for commercial real estate investors.
The Investor Side of a Bridge Loan
There are two primary methods that commercial real estate investors use to leverage bridge loans in their investment portfolios: bridge loan borrowers and real estate lenders.
Bridge Loan Borrowers
Bridge loan borrowers are made up of real estate investors of all types. They may be property owners or be pursuing a fix-and-flip. They may even be seeking to purchase and hold an investment property for an extended period. Ultimately, bridge loan borrowers are seeking out temporary financing for a wide range of reasons with the core purpose of growing wealth. Because the application of bridge loans is so broad, borrowers can use them for real estate opportunities that provide either passive or active income.
Real Estate Lenders
While bridge loan borrowers represent one side of the loan equation, the other side belongs to the lenders who provide the financing. These lenders may be private companies, investors, or both; while the bridge loan carries risk, collateral and higher interest rates make bridge loans attractive to many investors. While these opportunities require upfront capital, they do hold the potential to provide passive income secured by real estate.
Bridge Loans and You
You may never come across a situation in your financial future which calls for a bridge loan, but understanding how they work for borrowers, lenders, and investors is crucial to clearing up the confusion that often comes with bridge loans. As always, consider this as a primer – not a prescription. You and your financial advisor will determine which investment strategies and financial opportunities apply to your situation. You may not ever apply all the knowledge you’ve collected through your research; it’s the practice of learning that can create a bridge to success.
This article was originally posted on March 28, 2016, and updated on September 08, 2017.
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