As the real estate market rebounds, bridge loans can provide an interim financing option for investors and developers until they are able to secure long-term financing. While such loans provide several benefits, they also come with some disadvantages worth weighing before jumping into the loan.
Advantages of Bridge Loans
Bridge loans provide immediate cash flow and allow borrowers and investors to pay current obligations. These loans are generally taken out when a borrower is looking to purchase a new home before the current one is sold. Additionally, this type of financing is particularly attractive for investors in underperforming multifamily properties. Traditional lenders prefer more stabilized properties, thus making it difficult to obtain financing to increase occupancy, make improvements or retain management. A bridge loan running from 12 to 24 months 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. Monthly payments may not be due immediately since a borrower can opt to repay the loan before or after long-term financing is found. If the borrower takes the former option, it 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.
Such loans typically require less income documentation than conventional loans and tend to close quickly. They also can be nonrecourse in order to protect the borrower's other assets.
The Disadvantages
Bridge loans feature higher interest rates, fees and penalties, and generally require a large balloon payment. Closing costs are usually high and cannot be recovered if you find long-term financing sooner than expected. Bridge loans also require a high loan-to-value ratio and put you at risk of losing your property over a relatively small loan amount.
If you choose to pay off the bridge loan after obtaining long-term financing, you will incur greater interest expense. And if the long-term financing falls through, you will be left scrambling to make the payment out of your own pocket.
Proceed with Caution
Only savvy, well-capitalized borrowers should consider bridge loans. The loans are especially appropriate for newer, large multifamily properties (at least 100 units) in stable or improving markets with solid and expanding employment bases.
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.
