A bridge loan also known as a swing loan, fix & flip loan, interim financing, or gap financing- is a type of short-term financing used in real estate transactions to provide flexible cash flow; they often have a speedier application, approval, and financing procedure than standard loans, with a median approval time of 14 days. However, in exchange for ease and flexibility, these loans often feature high-interest rates, substantial origination costs, and shorter loan terms ranging from 6 to 24 months.
Investors are ready to pay higher interest rates since they understand the loan is just for a short period of time and want to repay it quickly with low-interest long-term financing or after they renovated and sold the property in the case of a fix & flip.
A bridge loan can help buyers get a leg up over bidding competition in a hot/seller’s market. Sellers that are interested in a quick sale will favor a bridge loan offer because the buyer has the money to close quickly. For example, an investor might take out a bridge loan against a property they are selling in order to purchase or act on another investment property immediately with no need to sell other assets.
Pros of bridge loans
- Not all lenders require an appraisal.
- No pre-payment penalties.
- Higher Loan to Values than regular loans.
- Option for Interest only.
- Borrowers can get faster access to cash.
- Quicker application, underwriting & closing process than traditional loans.
Fix & Flip Loans
Fix and flip loans, are used by real estate investors to acquire properties, make improvements to them, and then resell them for a profit. This type of loan includes two parts: the purchase and the funds for the rehab.
The purchasing is quite simple. The lender will often size the overall loan amount to the project’s total cost in comparison to the forecasted after-repair value (ARV) – see example below.
The procedure for making the purchase is comparable to other mortgage financing methods. You fill out an application and offer supporting materials. You must also submit a business plan for the property, which must include a thorough rehabilitation project with a timeframe and related costs broken down by each step. After your loan application has been accepted, you close on the purchase, often with you paying the down payment and the lender covering the balance of the cost.
The rehab stage is where things get interesting. Now that you are the owner, you want to start making improvements. To purchase supplies and pay contractors, you need money. You ask the lender for something known as a “construction draw” once you’ve finished a portion of the work related to your remodeling project. This means that the investor may ask for compensation after completing modifications. The lender will send an inspector to the property to authorize the work after receiving the request; this process often takes up to 72 hours. The investor must then wait for the lender to disburse the cash after receiving the inspection report. You need to have enough cash on hand to pay for more supplies and construction services if you want your project to continue moving forward in the meantime.
After Repair Value (ARV)
Let’s assume that the property costs $100,000 and that the renovation costs $50,000. The entire cost to make this property marketable was $150,000. You’ve done your research, and you think you can recoup $200,000 from the sale of the property.(profit of 50,000$)
The lender will do its own investigation to ascertain whether your investment estimates are precise, and your asking price is reasonable. Given that its results support your data, it consents to grant you a loan for $130,000, or 65 percent of the ARV. You just need to contribute $20,000, or 10% of the ARV, in this scenario.
Bridge Loan Costs
Depending on the loan amount and your creditworthiness, bridge loan interest rates typically start from 9.5%. Borrowers are required to pay the origination/ Lender’s fees which can range from 2% to 4% of the loan amount. Closing fees include title fees, title insurance, legal fees, notary fees, and an appraisal if required. around 2% on a loan amount of $300,000.
How to repay a bridge loan
The lender will want to know how the investor expects to repay the bridge loan when underwriting it. Investors have several exit choices, including selling their property or finding other long-term financing solutions. It is crucial to negotiate repayment terms with your lender and understand the next steps.