Most relevant to companies and, especially, investors in real estate, bridge loans can be helpful in a pinch when seeking more stable financing and to pay bills in the interim. They are usually approved and processed faster than traditional loans. There are potential drawbacks, however.
But what exactly is a bridge loan and how does it work? Dive in to find answers to these questions below.
This is a short-term loan a company or individual employs until more permanent financing is secured, and to satisfy obligations until that comes through. Such loans “bridge the gap” between the period when financing is needed but yet unavailable and on average last six months to a year, up to about three years.
Such loans usually carry higher interest rates and typically require collateral, such as property or business inventory.
Lenders can tailor such loans, also called bridging loans or bridge financing in real estate, to suit a myriad of situations. Terms, fees, and conditions can vary broadly among transactions and lenders. For example, while some loans are meant to repay a first mortgage, others add new debt to the overall balance.
Say a homeowner seeks to buy a new house but their current home is not yet sold. The equity they have in their home can be used for a bridge loan for a down payment on a new home while they await a buyer. A bridge loan will roll the two houses’ mortgages together, providing the borrower with flexibility until their home is sold.
Depending on the lender and the situation, payment structure and costs can vary. Monthly payments may be required for some borrowers, while other lenders require upfront as well as end-term payments.
Do note, though, that in real estate, a bridge loan is not meant to supplant a traditional home loan because it is short term and is thus considered a type of non-mortgage loan.
Companies commonly apply for a bridge loan when they are awaiting long-term financing and need cash for expenses – payroll capital, utilities, rent, or inventory costs, for example – in the meantime.
Taking out a bridge loan comes with a number of fees, which can come out to be a few thousand dollars. Here are probable fees for a $10,000 loan:
Typically, borrowers must have excellent credit – usually, 740 or higher — as well as a low debt-to-income (DTI) ratio. Such a ratio is the percentage of one’s gross monthly income that is used to meet monthly obligations. A ratio of below 50% is preferable. Any higher, and a lender will usually consider them as having excessive debt relative to their monthly income.
Further, most lenders will permit an applicant to borrow up to 80% of their loan-to-value ratio, which measures the appraised value of a property one seeks to buy or refinance, against the loan amount sought. This means that the borrower must usually have at least 20% equity in their current home to be eligible.
Potential borrowers must apply with a lender, as they would with another loan type. Terms and conditions will vary, but would-be borrowers should first look at their home equity, their DTI ratio, and credit score. If all that checks out, they can inquire for a loan from a bank or credit union, non-qualified mortgage lender, or hard-money lender.
For example, in 2016, when Olayan America sought to buy the Cony Building in New York, it applied for a bridge loan from ING Capital, which was quickly approved. In turn, the loan permitted the company to swiftly seal the deal. The loan helped to cover part of the purchasing costs until more permanent, long-term funding could be secured.
It is true that, compared to traditional loans, the application, approval, and funding process for bridge loans is faster. In exchange, though, bridge loans have shorter repayment terms, higher interest rates, and high origination fees.
Like all loans, there are pros and cons, depending upon the needs and situation.
The primary benefit of bridge loans is that they provide needed, short-term cash flow. Also, most bridge loans carry no repayment penalties, and there are no restrictions on a homeowner who seeks to buy a new home and put their current home on the market.
Further, there is a chance the borrower will gain a few months of no payments, and they also may still purchase a new home after obviating the contingency to sell.
As for drawbacks, bridge loans carry higher interest rates than, for example, home equity lines of credit. Also, as they relate to real estate, such loans are usually limited to 80% of the two homes’ combined value. This means the borrower must have major equity in the original property, or sufficient liquid savings.
Further, while eligibility to own two homes is required, juggling two mortgages simultaneously, in addition to the bridge loan, can be stressful.
Rather than take out a bridge loan, investors have a number of options:
Yes, investing in bridge financing is possible. Such investments can provide a steady income stream if the borrower repays as promised. There are risks, however, so such investments are better suited for more experienced and knowledgeable investors. For example, if the borrower does not repay the loan has agreed to, the investor may get delayed interest payments, if at all.
There are many ways for investors to participate in the real estate market, which remains a popular option for several reasons: the possibility of steady passive income, the abundance of investment types, and potential property appreciation and tax benefits.
There is real estate private equity, for example — which targets high-net-worth investors and institutions — as well as real estate investment trusts (REITs). The latter are often likened to mutual funds and are particularly suited for those who seek passive real estate ownership with no responsibility for the property itself. Such offerings usually include apartments, retail spaces, office buildings, and hotels.
For example, Yieldstreet, the leading alternative investment platform, offers REITs with entry minimums as low as $10,000. This trust – Yieldstreet has the broadest selection of alternative investments available – makes equity investments in commercial real estate in primary markets and property types spanning industrial, retail, hospitality, self-storage, and multi-family.
Another important reason to put capital in real estate is that, as an alternative investment – an asset class other than stocks or bonds – it can diversify holdings. Creating a portfolio comprised of securities of varying types can mitigate overall risk, protect against inflation, and even improve returns. In fact, diversification is paramount to long-term investing success.
Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.
Often used in real estate, bridge loans provide short-term financing and the ability to cover obligations until more security financing is in place. Do note, though, the comparatively higher interest rates associated with such loans.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.