In the world of real estate and business it’s very common to hear about Bridge Financing. The concept is pretty straightforward but can be a bit confusing to understand at first.
I remember the first time I heard about bridge loans and my imagination went crazy, I had a picture in my head of an actual bridge getting built. Luckily that only lasted a few seconds and I heard the words “Bridge loans are used for short term financing” by the person who was explaining it to me.
Below, I’m going to share with you everything I learned about using bridge loans with regards to real estate. We’ll also explore some concepts for using a bridge loan when dealing with business assets and acquisition costs.
Quick note before we dive in: I’m also going to give you two real examples of when bridge loans have helped me with buying and selling real estate.
First, let’s start with the basics.
What Is A Bridge Loan?
In layman’s terms, the definition is this: A bridge loan is a short-term loan with a duration of 12 months or less and is used for financing a real estate or business transaction. It has higher financing costs overall, including a higher interest rate. The trade off for the higher costs is faster access to cash. The approval process is quick due to minimal underwriter requirements. Lastly, you’ll need some existing assets for collateral, such as real estate property, business assets, or some inventory before finalizing the loan with the lender.
Short Term Bridge Loan Costs
The costs are hard to estimate, but typically I’ve seen origination fees between 1.5% and 4% of the loan value, with interest rates as high as 6% to 12%. In other words, it’s much more expensive than your 3% first home mortgage or 6% SBA fixed business loan.
Examples Of When I Used A Bridge Loan
Example #1: Moving From My Townhome And Buying My First Single Family Home
When I was 21 I bought my first town-home with an FHA loan. After living in it for a couple of years I had built-up some equity and wanted to shop around for a detached house. I could not wait because I was tired of sharing walls with neighbors, etc.
My plan was to live in my town-home while I looked for my new home. After I moved out, I would rent it out to a tenant. I wanted to build up my real estate holdings. After calculating some costs with my mortgage broker I was going to need a 10% down payment for the new home purchase.
I had two choices for the financing. The first was getting a hard money loan, which would not be my first choice due to the high fees. Luckily, I had an alternative option because of my equity hold in my town-home. I was able to get a home equity line of credit instead. So I pulled equity out of my town-home with a non-owner occupied HELOC since it was going to be a rental property. A cash out second mortgage would have worked too.
So I bought my new home and rented out the town-home. It worked out perfectly and then I sold the town-home a few years later for a nice profit.
Example #2: A Fix N Flip Deal That Needed Lots Of Construction And Remodeling
One time I partnered up with another real estate investor for a fix n flip deal. They had the cash reserves and bought a foreclosed property. The property was a single family home with three bedrooms and two baths. It was a cosmetic fixer but it would need a full remodel for the kitchens and bathrooms.
The estimated cost for the construction was around fifty thousand. Since the investor who bought the property ran out of cash for the repairs it created an opportunity for me to bring some money to the table. So I took out a hard money loan against the property and I threw in some of my own cash. It was a bit risky but the deal was carefully researched and I knew the investor really well. I had no problem personally guaranteeing the loan.
The hard money would be used as a bridge loan. The collateral was the property getting fixed up and the best part was this: The hard money lender approved the loan based on the appraised value of the property after the improvements were made. This is why hard money loans are so popular for real estate investors and are used as bridge loans.
I Want To Clarify Some Things, Please Read This: If you read the previous two examples of when I actually used bridge financing you’ll discover it’s not the name of an actual type of loan product. It’s just a term used for getting any type of quick short term financing. Hard Money Loans is the most popular choice for short term financing for most real estate investors and homeowners. A HELOC can work fine too in the right circumstances.
Homeowner Benefits and Drawbacks For Using A Bridge Loan
- It allows you to bridge two real estate transactions at the same time as a homeowner. You pull money out of your existing home while it’s for sale so you can have a downpayment for your new home purchase. Once you buy your new home and sell your old one, you can take the proceeds and pay off the bridge loan.
- You might be able to get a few months of free payments if there not scheduled to be made right away.
- It might be a bit risky and could not go so well if you don’t sell your old home fast. You’ll be stuck with high interest rate payments and spend a lot in financing costs. You’ll also be stretching your budget floating an extra mortgage payment on your old home.
- You’ll put yourself in a very stressful financial situation juggling multiple house payments.
Real Estate Investor Benefits and Drawbacks For Using A Bridge Loan
- The collateral can be the projected value of the property after it is rehabbed.
- Underwriting is easy with only verification of your income, assets, debt and the property details. Then you get a quick final approval for your loan.
- Its only short term and most bridge loans are only for a year. Might also cost a lot in financing charges and fees.
How To Take Out A Bridge Loan
Before you decide on taking out a bridge loan and signing your name to legal documents, make sure you have a plan for how you’ll pay the money back.
Bridge loans are available in any city or state. Especially in places like Texas, Florida, California, Utah, San Francisco, and Seattle. To find a loan broker or financial lender in your town just get on Google and do a search for something like “bridge loan san francisco” or “bridge loan texas”.
Using your city name or state name after the term “bridge loan” will tell Google you’re looking for someone local that can help you.
You can also ask for a referral if you know a loan broker who specializes in hard money loans too. You can also check local online review sites like Google Places, Yelp, etc.
Popular Frequently Asked Questions About Bridge Loans
Can I buy a home with a bridge loan instead of a mortgage?
Yes you can, as long as you qualify and have a plan to pay it back in a short term which is typically one year or less.
What are the average fees for a bridge loan?
I’m looking at a recent closing statement from my last hard money loan that was 100k, here’s an average of the costs
- Admin fees (loan origination fees) are about $7500 (7.5% of the loan amount.)
- Appraisal fee was $400
- Escrow fee was $412
- Cashier’s check fee $12 – Wiring fee would have been $60, wow.
- Notary Fee – $35
- Misc Fees – $565
What is the minimum credit score for a bridge loan?
Because the loan is based on your ability to pay it back with existing income/cash reserves and its secured by collateral such as real estate, it won’t require a perfect credit score. Sometimes, they don’t even run a full credit check.
What will a seller think if I use my bridge loan for the purchase money?
They won’t know the difference, to them it will look like a cash payment for the most part. So you’ll move up the list in priority for having the best offer, if there is a bidding war.
When’s the best time to use a bridge loan for business?
If you’re starting a new business, sometimes a bridge loan can help you. For example, if you have secured a long term business loan that won’t fund right away, a bridge loan can be used to cover your start-up costs. The same is true for getting equity financing too.
What’s better for the long term? Bridge Loan vs. Traditional Financing
Based on what we’ve covered so far, the answer is traditional financing. Talk to you loan broker about all your available financing options. That’s what I did to learn about all the best options.
Financing is a great tool for putting together a business or real estate deal. Just make sure you do tons of research upfront and make sure you know exactly what you’re getting into before you sign your name to a loan application. Hard money loans and HELOCS have worked great for me in the past. Just use them wisely.