Bridge loans were all the rage among home buyers looking to climb the property ladder in the 1990s. Even into the 2000s, banks were still pretty willing to lend on bridge loans designed to help people buy better homes. They are not as common any more in residential real estate. But in commercial lending, bridge loans are as popular as they have ever been.
One of the most common questions Salt Lake City’s Actium Lending gets from first-time borrowers is how long loan terms tend to be. The first thing to note is that private lenders have a lot more flexibility than financial institutions. Not every private lender does things the same way.
Bridge Loans Are Short Term
The next thing to know, according to Actium Lending, is that bridge loans are short term loans by design. A typical bridge loan from a private lender has a term of 6-12 months. It is possible to go as long as 36 months if circumstances warrant, but terms that long are rare from bridge loans.
The reasoning here is simple. A bridge loan is not intended to be a primary form of funding for expensive commercial needs. As its name implies, it is intended to bridge a financial gap. For example, picture a real estate investor attempting to purchase a new rental property while at the same time liquidating some other properties in his portfolio.
A bridge loan can help that investor close on the new property right away. As he liquidates the other properties, proceeds from the sales are used to pay off the bridge loan. The bridge loan helped the investor meet an immediate need – closing on the new property. Meanwhile, sale of the other properties provided the future income necessary to make good on the loan.
Bridge Loans Are More Risky
Bridge loans carry more risk than traditional loans. Greater risk is yet another reason lenders prefer to keep terms short. The shorter the terms, the less exposure a lender faces.
What makes bridge loans riskier? They are almost entirely asset based. A lender like Actium would base its approval decision on the value of the property being purchased. In some cases, the firm might also look at other properties the borrower owns.
What a private lender doesn’t do is go to great lengths to demonstrate a borrower’s creditworthiness. Private bridge loans are not approved based on a borrower’s perceived ability to repay. They are approved based on asset value. That makes the loans more risky.
More Affordable Monthly Payments
In exchange for shorter terms, private lenders tend to offer more affordable monthly payments by structuring bridge loans as interest-only loans. Monthly payments only cover the interest. A borrower pays the principal with the final monthly payment.
The positive side is that bridge loans can be more affordable on a month-to-month basis. For an investor whose cash flow is limited, that is important. But the negative site is the balloon payment required at loan maturity. A borrower needs to produce the cash at the end of the loan or risk losing the property.
Exit Plans Matter to Lenders
Structuring loans as interest-only vehicles forces lenders to pay a lot of attention to exit plans. An exit plan is a borrower’s plan to pay the entire principal at loan maturity. Needless to say, the strength of an exit plan matters to the lender.
Exit plans are important because bridge loan terms rarely exceed 12 months. Lenders are usually not willing to go beyond 12 months because bridge loans are risky. That’s really it in a nutshell.
