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A bridge loan is a type of gap financing used to cover short-term financial obligations until more permanent financing can be secured or cash becomes available. Lasting anywhere from a few weeks to a year, bridge loans are an effective means of ensuring ample cashflow during periods of relatively illiquidity. In real-estate, bridge loans are typically used when a property owner needs or wants to buy one property before their current property has sold. Bridge loans can be a fantastic way to jumpstart a deal when cash is tight and time is of the essence. With that said, these short-term loans do not come without risks and considerations. In this article we’ll break down the major pros and cons of bridge loan financing for real estate lending.
Bridge Loan Pros
Bridge loans effectively let you use your property’s equity to buy another before the first has actually sold. Like a mortgage, bridge loans are secured debt. However, instead of offering the purchased property itself as collateral, bridge loans let you borrow against the equity in your existing property. By their nature, bridge loans can be secured more quickly than the traditional mortgage. This fast turnaround can be crucial during real-estate deals where the offer is contingent on the sale of another property. The buyer gets cash on hand to make an offer or a down payment, which will reduce the likelihood of that deal falling through or going to another buyer. And, as the saying goes, a bird in the hand is worth two in the bush! Fast financing lets the buyer take advantage of favorable market conditions that may not always be available in the future. This is what makes bridge loans so useful – they provide a quick cash injection and give the buyer options when other forms of financing aren’t viable.
Bridge Loan Cons
As useful as bridge loans can be, they’re not without some drawbacks. Like any short-term, higher-risk financing, bridge loans incur higher interest rates – typically between 9.5% and 10.5% [Source]. Expect to pay handsome administrative fees as well. Lenders often want to be confident the borrower’s existing property will sell before they hand out credit, and that due diligence calls for higher than average time and expertise. And remember that bridge loans only last six to twelve months at most, so these costs can compound if a borrower relies on this type of financing frequently.
While the approval time is quicker than long term mortgages, bridge loans are not necessarily easier to obtain. Your lender will consider your credit-worthiness, debt-to-income ratio, and equity in your existing property. A borrower with a less-than-stellar record may be denied, even if they’re confident their existing property will sell. If approved, expect to get up to 80% of your current property’s equity. So, a $300,000 property with $100,000 left on the mortgage can allow for up to $160,000 in financing. With that in mind, a bridge loan may not provide enough cash for someone who recently acquired a property and is looking to offload it. In addition, bridge loans work best when the borrower is confident their current property will sell. If it does not, there’s a possibility they’ll have to hold two mortgages simultaneously. Not fun.
When compared apples to apples, bridge loans are more expensive than standard home equity loans. If you have the cash, time, or both – you’ll likely save more money in the long run taking a more traditional route. That being said, there are times when a bridge loan is the best choice available to a property owner in need of financing. Like any lending arrangement, shop around for favorable rates and be sure to do your homework before signing the dotted line.
If you have any questions about bridge loans, don't hesitate to contact RCN Capital.