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Financing an investment property is a challenge for new and seasoned investors alike. It can be particularly tricky if the property needs work and won’t secure the necessary capital needed before repairs can begin. Enter the bridge loan.
Bridge loans are short-term loans used to finance the purchase of an investment property until long-term financing can be obtained or the property can be rehabbed and sold. They are popular among real estate investors because they provide quick access to funds for a property purchase, but they also come with some challenges.
Here’s more information about bridge loans, along with four pros and cons of using bridge loans for investment properties.
Bridge loans for investment properties
As a real estate professional, you may be familiar with using a bridge loan for a residential purchase. This is a good option for homeowners who need to relocate before selling their previous home — the loan “bridges” the gap between cashing in on a home’s equity and using it to purchase a new house.
But bridge loans can be a great tool for investment properties, too. These are sometimes referred to as “fix it and flip” loans that give investors working capital to make necessary repairs before selling.
Unlike loans for a traditional home, which are secured by the assessed value of the home, bridge loans for investment properties are granted based on different criteria: After Repair Value and Loan to Cost Ratio.
- After Repair Value (ARV): The loan amount is calculated based on the home’s projected value when repairs are completed.
- Loan to Cost (LTC) Ratio: These are loans for investment properties projected to make a profit that is less than 50 percent of the projected value.
Four pros of bridge loans for investment properties
Bridge loans offer real estate investors some significant benefits. Here are four reasons to consider them:
1. Speed and flexibility
Bridge loans offer a quick and flexible way to finance an investment property. They can be approved and funded within a few days, making them an ideal option for real estate investors who need cash in hand to close a deal quickly.
This can also be very helpful for investors looking to avoid paying capital gains tax. There are rules governing how long a home seller has to reinvest profits from a sale to avoid taxes. With a bridge loan in hand (and closing documents ready to go), it’s easier to reinvest the proceeds without penalty.
2. Customizable repayment terms
Although bridge loans have a short term (more on that below), their repayment terms are often customizable. You can elect to repay only the interest until the investment property sells, or you can defer payment until closing.
And unlike some traditional loans, bridge loans do not have prepayment penalties, which means that the borrower can repay the loan whenever they want without incurring additional fees. This gives the borrower more control over their finances and the ability to pay off the loan faster if they choose.
3. No personal guarantee required
Bridge loans do not typically require a personal guarantee from the borrower, which means that the borrower’s personal assets are not at risk if they are unable to repay the loan. This is a significant advantage for real estate investors who want to protect their personal finances.
This does not mean that a bridge loan is unsecured. As with traditional loans, the investment property secures the loan. But in the event of a default an investor’s personal interests are protected.
4. Ability to leverage equity
Bridge loans allow real estate investors to leverage the equity in their current property to finance the purchase of a new property. This can be especially beneficial for investors who want to purchase multiple properties.
And speed is of the essence. Even with home prices exceeding inflation by 207 percent since 2023, rising interest rates make having quick cash on hand critical for motivated investors.
Four cons of bridge loans for investment properties
But bridge loans aren’t all fast cash and flexibility. Here are four cons to keep in mind.
1. High interest rates
All that convenience and flexibility does not come cheap.
Bridge loans typically have higher interest rates than traditional loans — between 8.5 percent and 10.5 percent. Even with a shorter term, these are comparatively more expensive over time. This can be a significant disadvantage for real estate investors who are looking to maximize their return on investment.
2. Short repayment term
Bridge loans also have a short repayment term, which means that the borrower must repay the loan within six months to a year. This has more of an impact for investors taking on a large investment property that needs a total overhaul. It can also be challenging for those who need more time to secure long-term financing.
If you are just getting into the world of “fix and flip” properties, starting small is a better option. This gives you more time to understand how long rehabbing takes (hint: it’s often much longer than you think!) so that you have plenty of time to sell before the loan is due.
3. Strict lending criteria
Bridge loans use qualifying criteria similar to their traditional counterparts: credit score and debt-to-income (DTI) ratio. But unlike traditional loans that have a variety of options for those with less-than-stellar credit, bridge loans are typically only available to borrowers with strong credit and financial histories. This means that real estate investors who have a less-than-perfect credit history (or not much credit history to begin with) may not be eligible for a bridge loan.
Also, bridge loans are usually only able to finance 80 percent of the projected value, so you may still need to pay out of pocket for some costs.
4. Potential for default
If a real estate investor is unable to secure long-term financing within the specified repayment term, they may default on the bridge loan and lose the investment property. For new investors seeking to establish credit and a reputation with local lenders, this can be a significant financial setback that could have long-term consequences for their finances and credit history.
The bottom line
Bridge loans offer real estate investors a quick and flexible way to finance an investment property, but they also come with some significant disadvantages. Before taking out a bridge loan, it is important to carefully consider the pros and cons and determine whether it is the right financing option for your investment needs.