For real estate investors and house hunters, bridge loans can be a great source of quick financing.
They can be used to make a down payment on a new home while trying to sell your old one, or cover renovation costs on a property you want to fix up and flip. That being said, they come with a certain measure of risk. As a result, the pros and cons of bridge loans must be carefully considered before you apply for one.
What is a Bridge Loan?
A bridge loan is borrowing against the equity of an existing property in order to purchase a new one. Essentially, it’s a temporary source of financing to cover immediate costs or tide an investor over until he or she can access a more permanent source of financing.
For property investors, a private money bridge loan can be used to cover the costs of any unforeseen issues in the renovation phase of the fix-up-and-flip project, such as the need to hire additional construction sub-contractors to speed up the job.
Bridge loans have short lifespans – typically anywhere from six months to two years. Due to their short-termism, lenders charge higher interest rates of around 7.5%-12% percent on bridge loans.
How Does A Private Money Bridge Loan Differ from Other Bridge Loans?
Whether a bridge loan is secured from a credit union or a private money lender, the main differences will be seen in the qualification process and also in the types of properties that will qualify.
Bridge loans secured from a bank would be a prudent move if you have the luxury of time on your hands for intensive document collection, have a very favorable credit score, and if your property has equity backed by collateral. On the other hand, a bridge loan from a private money lender is ideal for a property that isn’t a perfect asset (i.e. needs to be repositioned or renovated). Private money bridge loans also don’t require the borrower or entity to have a perfect credit score or the submission of an extensive amount of documentation in order to apply.
Although other forms of bridge loans can also be used to buy other assets besides investment properties, in this blog, we’ll focus on when private money bridge loans are used exclusively for real estate.
Check out our guide Bridge Loan Vs Private Money Loan [What You Need To Know] to get a more detailed explanation of the similarities and differences between the two.
The Pros and Cons of Private Money Bridge Loans
Whether you need quick cash to inject into your fix and flip property – to smooth over renovation or construction delays, for example – there are a number of factors to consider before deciding whether or not a private money bridge loan is right for you.
- No need for an income statement – Bridge loans from private lenders are exempt from federal regulations that require you to provide income documentation or a credit score. Therefore, the money made from the sale of your existing property can also be put towards paying back the loan.
- Flexible repayment options – Private money lenders are accustomed to fix and flip projects not going as originally planned, or an exit strategy taking longer than previously determined. In cases like these, payments can be deferred, or made into an interest payment-only arrangement until the sale of an existing property is made.
- Quick access to funds – As private money bridge loans are privately funded and secured by the property’s value, lenders don’t take into account your credit rating. As a result, they’re approved in a much shorter time frame than a traditional loan. On average, bridge loans from private lenders are assessed and approved in around 3-7 days.
Want to know more about how private money loans work? Read our Private Money Loans Explained guide.
- Small pay-back window, high-interest rates – Bridge loans typically have higher interest rates compared to conventional lenders, and the loan needs to be paid in a relatively brief period of time. So while you’ll only have to pay the interest rate for a few months before the loan is repaid, the interest can be as high as 15% or more of the complete loan amount.
- Increased risk and debt – All loans come with a certain level of risk; bridge loans are no exception. In some cases, property investors will split the loan over two properties. This means that, for a time, you’ll be required to pay two or three loans back all at once. This could put a strain on your projected fix-and-flip budget. Furthermore, if hard financial times strike, it could put you in a difficult financial situation.
- Additional fees and transaction costs – Everything from administration, appraisal, escrow, and an origination fee can be tacked onto a bridge loan. The fees differ from state to state but could be as high as 15% of the overall loan in some cases. And after the sale of flipping a home, many property investors can expect to pay 3-6% of the sale price to real estate agents managing the transaction. This could cut deeply into an investor’s profit margin.
Are Bridge Loans Right For You?
Choosing the right kind of financing will ultimately depend upon your financial situation, overall goal, the state of the housing market, and your geographic location. If you’re looking for the best financing option for a fix and flip, a distressed property, or a rental property that is not yet income producing, you’ll find that a private money bridge loan will likely be the most reasonable solution.
One thing to keep in mind when weighing up the pros and cons of private money bridge loans is that there’s a risk in almost any kind of monetary transaction. It’s key you have all the facts and figures in front of you. That way, the risk is minimized and the chances of success – like flipping a distressed property for a tidy profit – are greatly maximized.
Whatever financing route you go down, make sure you get advice from your real estate dream team – including an experienced private money lender. This way you can be assured that you’ve made the right call.