In this series of articles (“Beyond Banks”), we explore borrowing opportunities from ALL sources, not just your traditional bank. To access all the volumes in this series, go to our “Series” page here.
What is a bridge loan?
A bridge loan is a short-term mortgage loan that allows the borrower to quickly secure funds to cover a pressing need. It acts as a “bridge” until the borrower is able to pay off the loan or secure more permanent financing.
Bridge loans are characterized by their short terms (usually ranging from six months to two or three years) and high interest rates (can be as high as into the double-digits). These loans are usually interest-only for the life of the loan, with a balloon payment due at the end.
Also known as “gap loans,” “swing loans,” “interim loans,” and “hard money loans,” bridge financing is used in the commercial real estate setting and, less frequently, in the residential context.
Bridge lending comes into play when permanent financing is not an option. For example, the property at issue may be suffering from poor conditions, such as a multifamily building with low occupancy rates. Or it may be too speculative or difficult to assess the true value of the property, such as a construction project that has not broken ground yet.
Because the property itself serves as the primary (if not the only) collateral, bridge mortgages are risky endeavors for lenders. Due to the high level of risk, traditional banks are reluctant to extend these loans. To fill this niche, many alternative lenders have carved out a specialty for bridge financing.
While these bridge lenders charge higher interest rates than traditional banks, the tradeoff is certainty of execution and speed — two traits that traditional banks are not known for. For instance, some bridge lenders can close the loan as fast as a couple of weeks.
What are some typical reasons for getting a bridge loan?
In the commercial real estate context, companies take out bridge loans as a temporary stopgap where conventional, permanent loans are not available.
These loans provide immediate cash flow to get companies through a variety of temporary, short-term phases, including:
- Until construction or renovation of the property is completed;
- Until a round of investor fundraising closes;
- Until the company’s Chapter 11 bankruptcy ends (this financing is known as debtor-in-possession or DIP financing);
- Until a partner buy-out is completed; or
- Until an acquisition of a new piece of real estate is finished.
Bridge lenders are willing to loan for a wide variety of commercial property types (whether the property will be owner-occupied or for investment purposes) including automotive, condos, golf courses, hotels, industrial, marinas, medical, mixed-use, mobile home parks, multifamily, offices, retail, self-storage, and senior care facilities. These lenders also have bridge programs for foreign nationals.
In the residential real estate context, individuals use bridge loans to enable them to buy a new house before selling their existing house. Compared to commercial, residential bridge loans are far less common. As with commercial, very few traditional banks offer residential bridge financing.
Bottom line, whether you are looking for a commercial or a residential bridge loan, you will likely have to turn to a private or hard money lender that specializes in this type of lending.
The importance of having a good exit strategy
Because these loans are so short, and are interest-only with a balloon payment not due until the end of the term, bridge lenders need to be reassured that the borrower has a clear exit strategy in place.
This can entail paying off the bridge loan or refinancing into a longer-term loan.
Here are some common borrower exit strategies for commercial bridge loans:
- Sell or flip the property and use the proceeds to pay off the loan;
- Sell other investments to pay off the loan; or
- Add value to the property through renovations (e.g., rehabbing a warehouse, or upgrading a multifamily property to increase rental income) and then refinance into a stabilized permanent mortgage at a lower interest rate.
Bridge loans give companies and individuals the fast access they need to immediate funds to get them through pressing, short-term situations. While traditional banks tend to steer clear of this area, there are many alternative lenders that specialize in these loans. With a bridge loan and a clearly defined exit strategy, it is possible to smoothly go from Point A to Point B.
Continue exploring our “Beyond Banks” series:
To access all the volumes in this series, go to our “Series” page here.
David A. Krebs is a licensed mortgage broker offering commercial and residential loan programs beyond your regular bank. Call us at 321-239-2781, click here to submit a message, or click here to book a free consultation.