How to Get a Bridge Loan to Develop Your Property
Real estate development can be a lucrative venture but it typically requires a large amount of capital to get a project off the ground. When cash reserves are low and time is short, obtaining a bridge loan can be a viable option for moving forward.
What is a Bridge Loan and How Does It Work?
A bridge loan is a form of temporary financing available for real estate investors and developers who need to raise capital quickly until an alternate source of financing can be finalized. The types of properties that can be developed using a bridge loan include office buildings, retail space, medical buildings and multi-unit housing structures. Some lenders also offer bridge financing for non-owner occupied single family homes.
Bridge loans are designed to act as a stopgap for the borrower until conventional commercial loan financing is able to be secured. Bridge loan terms typically range from one month to one year, although some lenders may allow borrowers to extend the term for up to five years. The amount that can be financed through a bridge loan can range from $25,000 to $5 million, depending on the lender.
A bridge loan is usually paid back when the borrower either sells the property in question or obtains conventional financing. In the meantime, the property acts as collateral for the loan. While lenders typically do not charge upfront fees for bridge loans, some do assess a prepayment penalty if the loan is repaid ahead of schedule.
How to Calculate the Amount of a Bridge Loan
Bridge loans are not intended to be a permanent financial solution and as such, they tend to carry much higher interest rates compared to conventional financing. When contemplating a bridge loan, it’s important to be clear about what amount is necessary to cover the development project in the interim and how the long-term cost of borrowing adds up.
For example, assume that you qualify for $500,000 in bridge financing to develop an office building you purchased. The loan comes with an interest rate of 12%, plus three points. With a 12-month term, the total interest payments on the loan would total approximately $60,000. Once the points are deducted, the loan proceeds would come to $485,000, so the effective cost of financing would be over 15%.
When gauging what size bridge loan is needed, it’s important to factor in the points and interest. Failing to do so could create a problematic gap in funding. It’s also necessary to consider the loan to value ratio that can be used to qualify. Depending on the lender, the maximum loan amount may be capped at anywhere from 60% to 80% of the property’s appraised value.
When to Use a Bridge Loan
Applying for a traditional commercial loan is not a quick process. It can take weeks or even months for the lender to review the borrower’s financial details, make a final approval decision and underwrite the loan. Bridge loans, by comparison, are primarily designed to be used in circumstances where time is of the essence.
In terms of property development, a bridge loan may be appropriate when you’re operating on a tight schedule and can’t afford a delay. It’s possible to receive the proceeds of a bridge loan in as little as two weeks after getting approved, which can make a substantial difference in how quickly a property can be renovated and re-leased or put on the market.
A bridge loan can also be helpful when attempting to develop a property that doesn’t meet the lender’s standards for approval. For instance, it may be possible to use a bridge loan to complete renovations of a distressed commercial property that a bank would not be willing to touch otherwise.
Finally, a bridge loan may be worth considering when it’s not possible to obtain conventional financing because of a borrower’s poor credit history. If that’s the case, a bridge loan from a hard money lender may be the answer. Hard money loans are funded by private investors and consequently carry the highest interest rates.
Qualifying for a Bridge Loan
Approval for a bridge loan does rest on some specific guidelines, beginning with the borrower’s financial details. That includes your personal credit score and debt service coverage ratio. This is the ratio of net operating income generated by the property annually versus its annual mortgage debt service.
In addition to these factors, lenders will also examine the details of the property itself, including its value and the amount of equity the borrower has. This, more so than your credit, is the main focus when dealing with a hard money lender.
The equity value acts as a safeguard for the lender, who is assuming a high degree of risk in granting the loan. The amount of equity required varies from lender to lender but it may range from 20% to 40%.
Finding Bridge Loan Financing
There are two avenues available for pursuing bridge loan financing. The first is to contact a traditional bank that offers these types of loans. Keep in mind, however, that qualifying can be challenging since banks may be more reluctant to take a gamble on a development project if they perceive it as higher risk.
Alternative lenders, on the other hand, may be more receptive to helping you meet your financial needs. A quick Internet search will provide dozens of listings for private bridge financing, including hard money lenders and real estate crowdfunding.
When comparing the different lending options, it’s advisable to pay close attention to the fees, rates and terms each lender is offering. Pulling the trigger on bridge loan financing without understanding the full ramifications of what you’re borrowing could be disastrous for the final outcome of your development project.