United States: Crossing That Bridge: Understanding The Pros And Cons Of Bridge Loans

Investors and home buyers generally use bridge loans until they can secure long-term financing. As with any form of financing, there are advantages and disadvantages.

What Is a Bridge Loan?

A bridge loan is a short-term loan that bridges the gap between the sale price of a new property and mortgage in cases where the existing property has not yet been sold. Generally, bridge loans are secured by the existing real estate and used as a down payment on the new property. Typical bridge loans are for a term of one year or less. However, for a fee, many lenders will give the bridge loan borrowers the option to extend for an additional six months to one year. A bridge loan is typically paid off when the owner places permanent financing on the property. Because of their short- term nature, bridge loans usually do not have any prepayment penalties. And, they are versatile. Bridge loans can be used for home buyers and to purchase or refinance many different types of projects, including apartment complexes, retail property, office buildings and hotels.For example, suppose you plan to renovate 50% of the units in a multifamily property by installing new kitchen appliances, granite counter tops and new flooring. You might apply for a bridge loan at the start of the renovation project. Once you complete the renovations, you plan to raise rental rates given the new, high quality finishes of the units. Moreover, you hope that your improvements will stabilize the property's income stream by lowering the vacancy rate and tenant turnover.

Are There Benefits?

Bridge loans are particularly attractive these days for investors in under-performing multifamily properties. Traditional lenders generally prefer more stabilized properties, making it difficult to obtain financing to increase occupancy, make improvements or retain smarter management. A bridge loan can give investors the opportunity to address the issues necessary to stabilize a property to the satisfaction of traditional lenders.

Bridge loans are also appealing because of the borrower's ability to choose repayment options. Payments may not be required for a few months and a borrower can opt to repay the loan before or after long-term financing is found. A borrower can improve its credit rating by making the payments on time, thereby improving its odds of qualifying for long-term loans with favorable terms. If the bridge loan is to be paid off after long-term financing is secured, part of that financing can be applied to repay the loan.

Additionally, bridge loans tend to require less income documentation than conventional loans and typically close quickly. So, bridge financing allows investors to jump on market opportunities before competitors who are using traditional financing. Bridge loans also can be nonrecourse, which helps protect the borrower's other assets.

What Is the Downside?

Not surprisingly, bridge loans usually feature higher interest rates, fees and penalties and require a large balloon payment at the end of the term. Similar to other property loans, fees for these types of loans can include:

  • Administration fees;
  • Appraisal fees;
  • Escrow fees;
  • Title;
  • Notary fees;
  • Wiring fees; and
  • Loan origination fees.

Your closing costs will usually be high with a bridge loan; and, like other loans, you cannot recover them if you find long-term financing sooner than expected. Generally, if you choose not to pay off the bridge loan after obtaining long-term financing, you will incur greater interest expense because you will have two loans simultaneously on the same property. If your long-term financing falls through and you have to make the balloon payment out of your own pocket, but you are unable, the bank may ultimately decide to foreclose on the property.

Time to Decide

So, is a bridge loan what you need? In the right situation, a bridge loan may be the best way to proceed. Ask your financial advisor about whether this type of financing is right for you.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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