By Douglas Katz – 12/08/2022
The world of real estate investment can and often is fast paced. Sometimes getting the property is a matter of having readily available financing in place. There are many different options to fund a project but when speed is of the essence, a bridge loan is usually the best tool in the tool kit. If you need to go down to bridge loan path, you need to know the costs and benefits of the financing structure.
When you think of a bridge loan, think of a short-term financing option that fills a gap for an investor who has not yet secured more permanent financing. In fact, bridge loans are interchangeably referred to as gap loans or gap financing.
Like all financing structures, bridge loans have some great benefits, but they also have some important considerations.
- Fast Process – Because they are usually heavily based on the collateral for which the bridge financing is intended. While there will be minimum FICO and other basic credit requirements, the complexity and inconvenience of full documentation is rarely if ever required. Generally, these requirements are specific to the lender and not part of a larger regulatory environment. While this lack of oversite makes bridge loans riskier for the borrower, the process is much simpler and more efficient.
- Experience Benefits Terms – No factor better enables a lender to evaluate the ability of a borrower to repay an investment real estate loan than experience. Experienced investors with good and verifiable track records will likely find better terms.
- Flexibility for Terms – While primarily for acquisition, many bridge loans also allow for minor renovation or aesthetic upgrades to the property. The allowable work will have limitations after which the need for renovation financing will be required, but if the property just needs a facelift, bridge financing can often meet your needs.
- Flexibility for Property Type – Many financing options in the investment space are limited to 4 or fewer units. Because they are short-term, which mitigates the risk, bridge loans for investments with 5 or greater units are readily available. Since they are short-term loans, any investor using a bridge should have take out financing lined up to avoid a problem at the end. Multi-unit financing can be super-complex which means that while a bridge can buy time, it cannot replace more appropriate financing.
- Short-Term – Bridge loans are not meant to be a permanent solution. They are efficient and cost effective as long as used correctly. Over time, interest costs and possible penalties can add up making them much more costly. Planning accordingly is necessary and essential.
- Cost – Because these loans are short-term, the lender needs to make their money during the loan term. Expect more robust fees and higher rates than you would see with more traditional financing. Remember, the lender is helping you acquire a property quickly and without hassle and for that they expect to be compensated.
- Lack of Regulation – This is the flip side of the easy part. One main reason that these programs can provide rapid funding is that they are not encumbered by the same regulatory requirements as traditional financing. You as the consumer trade speed and convenience for some of the protections that ensure your interests are safeguarded. Caveat Emptor or let the buyer beware should be top of mind.
Bridge loans are a necessary tool. I get a lot of calls from investors who need to move fast and the reasons can range from a motivated seller offering amazing terms for a quick close or to backfill financing for a client whose primary financing has fallen through. Regardless of the reason, bridge loans can fill a effectively and efficiently fill a gap but any investor considering bridge financing must fully understand the costs and benefits as well as their exit strategy to maximize the former and minimize the latter.