Real Estate Financing: Bank Loans or Bridge Loans?
If you are buying commercial real estate as an investment, there are two main types of loans available to you. Bank loans are the traditional amortizing instruments that require good credit and large down payments to access low interest rates and long repayment terms. Bridge loans, on the other hand, are short-term devices that offer low to no down payment and interest-only monthly payments. So, which one should you use for your next investment?
Bank Loans: Advantages and Disadvantages
Loans from banks are designed to be significantly more difficult to get than most other types because commercial properties are quite expensive and long-term loans are riskier than shorter term instruments. Essentially, to the bank the facts of life are that the longer the loan is out there, the more chances you have to hit financial trouble and default. Short-term lending professionals can generally predict your financial health will be similar to the way it is at application with some confidence, but long-term loans that span a decade or more do not carry that level of probability.
As a result of this situation, commercial real estate loans that come from banks tend to require a hefty down payment that helps ensure the value of the loan can be recovered even if the building loses a degree of value on the way to default. They also require good credit and a long history of profitability along with a current business plan. Even then, it can take weeks to get approved.
The upsides, though, are that it is quite easy to get to a return on your investment when you only had to put a fraction of the capital for the purchase down to get a low monthly payment. It’s a lot easier to recoup 30% of an income property’s value than it is the full thing, after all.
Bridge Loans for Short-Term Lending
Flippers and other short-term investors prefer bridge loans because the sizable principal payoff is generally handled by the resale of the property after improvement so the interest-only monthly payments and the down payment become the only costs to acquire the building. Since many commercial real estate lenders offer their highest LTVs on the shortest bridge loan terms, this can result in an investor being able to acquire properties with no money down under the right circumstances.
There are a lot more risks to the borrower with bridge loans if the property does not sell on time, but they can be refinanced if needed. The more that happens, though, the more it cuts into your bottom line by increasing project costs. Keep that in mind when you are shopping for your next real estate loan.