Pros and Cons of Bridging Loans

Bridge loans are commonly seen in commercial lending, with some availability in the residential market to assist home buyers with very special circumstances. A bridge loan is a form of a “hard money loan”. Hard money loans are known for several traits: short term, higher fees, higher interest, more real property security, and lower documentation needs.

The name derives from the basic purpose of a bridge loan: to bridge a gap in capital due to cash flow problems, periods between venture capital investment, or in residential real estate, to allow the closing on one home to occur prior to the sale of the buyer’s original home. 

Advantages of a Bridge Loan:

* These loans require less income documentation. 

* Bridge loan amounts are determined by value of property available to capitalize, not on income or credit rating.

* Bridge lending tends to occur fast as it is primarily a commercial financing tool.

* Bridging loans are available when other portions of the credit market are locked up tight

* New construction would be virtually impossible without this financial tool

* These tools can be set up so there is never a payment due. Payments are made upfront out of the loan with the last balloon payment being the only payment.

* Avoids need for closing co-ordination between sale of an old home and purchasing a new home

Disadvantages of a Bridging Loan:

* High interest rates

* Short period with balloon payment

* High closing costs

* Closing costs are unrecoverable even if you find conventional financing sooner than planned

* Require a high loan-to-value ratio on the collateralized property.

* Risk of losing your property for a fairly small loan amount

* In commercial lending, some of the terms may include an equity portion in a project to the lender.

Bridge loans should only be used by people who understand them and can capably evaluate whether the high cost of the monies are truly worth the short term gain from having access to the cash. These loans, in the current low-interest market, generally run 12-14 percent and require up to four points paid at closing. This is very high for a real estate based loan. Borrowers can generally expect to pay an 8-12 percent premium or higher on bridge loans versus a comparable long-term mortgage.

Like many hard money borrowing tools, the bridge loan has its place. Consider carefully all the costs, and all your options, before seeking a bridge loan.