Pros and Cons of Bridge Loans

Everything you need to know when considering your next interim financing situation.

A bridge loan is a form of short-term financing most often used to purchase and/or renovate real estate properties. For commercial properties, a standard bridge loan can stretch from six months to one year, although many lenders grant extensions, typically for a small fee. Bridge loans are ideal for commercial property owners (and potential owners) who are looking for interim funding and need to force their way into the next property transaction. Essentially, they help you take advantage of time-sensitive opportunities and avoid liquidity restrictions. As the name suggests, bridge loans serve to “bridge” the gap between transactions. While bridge loan financing has plenty of benefits, it’s worth weighing the drawbacks before taking out a bridge loan.

 

PRO: Be fast and flexible

The primary advantage of bridge loans has to be the speed of which everything happens. Funding can be secured extremely quickly and the qualification process is much less laborious and intricate when compared to traditional lending. A quick close with a private lender can entice sellers and set your offer apart from other buyers with slower, conventional funding. For example, let’s say you wish to purchase a multifamily property worth $250,000. You have applied for long-term financing but since you know the property is in great demand, you obtain bridge loan financing to purchase the property and then pay off the bridge loan once your long-term loan is approved. Considering the average time-frame difference between bridge and traditional loan approvals (2 weeks versus 2-3 months) a bridge loans can a huge advantage in competitive markets.

 

CON: They’re not especially affordable

Bridge loans aren’t cheap. Due to the short-term length interest repayments are much larger when compared to a long-term traditional loan. Moreover, private lenders aren’t very flexible when it comes to late payments. Every month the loan isn’t repaid it gathers compound interest and bridge loan lenders will typically charge larger fees, interest rates, and penalties when payments are late—which can result in the borrower defaulting on the loan.

 

PRO: Flexible repayment options

Another important benefit of bridge financing is borrowers can choose to repay the loan before the long-term financing is accessible or after. In some cases, your real estate collateral will have an adequate interest reserve so that a larger loan can be granted, allowing you to receive more flexible terms of repayment.

CON: Relies on long-term financing

During economic downturns in our economy, it can be difficult to secure longer term finance options. Take for example the housing crisis around 2008—when many lenders got into financial problems and funding was withdrawn resulting in the borrower unable to get out of the bridging finance, naturally winding up defaulting on the loan. While we’re well past those days, bridge loans do depend on long-term financing and if that isn’t able to be secured you’re in trouble.

PRO: Your credit score isn’t everything

Your credit score—while key in traditional types of financing—doesn’t play a significant role for commercial bridge loans. That said, most bridge loan providers will check your credit, and will expect a credit score above 650. Your Debt-Service Coverage Ratio (DSCR) and net worth far outweigh your credit score when bridge loan lenders consider your application. In addition, if you’re able to make all the payments on time, your credit rating will improve significantly, allowing you to qualify for long-term loans you may otherwise be ineligible for.

CON: Potentially reduced price of property

If things don’t go as planned and your property doesn’t sell as quickly as you expected, you may find yourself in the position of having to lower the price to pay off the bridge loan. Frankly, commercial real estate development can be a gamble. With each property, you are hedging your bets that your collateral will sell at the rate you had initially anticipated.

About
Pyatt Broadmark Management is based in Seattle and offers private loans for real estate financing in Washington, Oregon and Idaho. Pyatt Broadmark Management has proven to be a valuable resource for builders, ‘fix and flip’ investment buyers and developers who require quick closings, “outside the box thinking” and the utmost professional service.
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