Bridge loans can supply short-term financing before developers and investors cement long-term financing. Their popularity surged during and in the wake of the Great Recession — and that popularity has continued till this day. But if you are considering obtaining a bridge loan as part of a new deal or a refinancing, or for on-site improvements, you need to learn the potential pros and cons.
Related Read: Crossing That Bridge: Understanding the Pros and Cons of Bridge Loans
Pros of bridge financing
The typical duration for a bridge loan is 12 to 36 months. This can give you the time to address issues that are preventing you from securing traditional financing or taking advantage of other opportunities. For example, bridge loans might help when you want to:
- Close a deal with an impending deadline;
- Make renovations;
- Get a property out of foreclosure;
- Stabilize cash flows;
- Pursue environmental remediation;
- Replace a tenant; or
- Improve your creditworthiness.
If you are looking for long-term financing, you can choose to pay off the bridge loan before or after you find it. You will improve your odds of receiving that financing by making timely payments on the bridge loan. Or, if you opt to pay it off after finding long-term financing, you can apply some of those funds to pay off the bridge loan.
In addition, bridge loans usually require less income documentation and close more quickly than traditional loans, getting the funds to you within a week or so. And they can be nonrecourse, allowing you to safeguard other assets.
Drawbacks of bridge financing
Bridge loans carry higher interest rates (usually based on market-based rates), transaction fees and closing costs than conventional loans. They generally also may require a high loan-to-value ratio and a large balloon payment.
Bridge loans are more closely monitored by lenders than traditional loans, too. As a result, you could incur costly penalties when, for example, you fail to satisfy complex debt-coverage ratios or debt-yield tests. If you plan to use long-term financing to pay off a bridge loan, you will be left on the hook for it if that financing does not come through. Should you fail to timely meet the payoff, interest costs will pile up fast. These concerns are particularly relevant given recent concerns about a looming recession.
There is also no guarantee that you will qualify for a bridge loan. Lenders tend to require exceptional credit, a low debt-to-income ratio and a significant chunk of equity.
Related Read: Is a Bridge Loan Right for Me?
In the right circumstances, bridge loans can provide a flexible and worthwhile solution to short-term funding needs. But they are not without substantial financial risk, so tread carefully before signing. Financial advisors can help determine whether a bridge loan is right for your project and negotiate the optimal terms with a lender.
For more information, contact Kathy Jeziorski at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.