Bridge loans and hard money lending are becoming more popular as mortgage guidelines continue to tighten for borrowers and the stock market is no longer a safe place for investors. These forms of alternative financing seem to be a win-win for all.
Bridge Loans
In a market where the time it will take for a home to sell is uncertain, some buyers making the choice to secure a bridge loan (also known as a swing loan or bridge financing). This type of a loan is designed to cover the gap between the time a buyer closes on their new home and the time in which their old house sells.
Bridge loans are typically one year in length. The loan is usually structured to pay off the buyer’s first home, minus closing costs and six months' of interest going toward the down payment for the new house. Occasionally a buyer may qualify for a loan that simply adds the cost of their new home to their current loan, but in this market this is rare.
Once the first house is sold, the bridge loan is paid off. Should the home not sell by the six-month mark, the buyer is then required to begin making interest-only payments. If the house sells within the first six months, any unearned interest will be credited back to the owner.
One of the advantages of a bridge loan is that it allows a buyer to make a competitive offer without a contingency clause, which will be more attractive to sellers. The high interest rates and short term are disadvantages of this type of alternative finance option.
Hard Money Loans
Hard money loans are another type of alternative finance option. Here a borrower obtains a loan from a private party, usually an investor and almost never issued by a commercial bank or other deposit institution. These loans are usually issued at a much higher interest rate than standard loans and are secured by the value of a parcel of real estate.
Hard Money vs. Bridge Loan
Hard money and bridge loans have very similar lending criteria and cost to the borrowers. The primary difference between the two is the credit worthiness of the borrower. A hard money loan often involves an asset-based loan at a high interest rate, and a borrower who is in a distressed financial situation, such as being behind in their existing mortgage or where bankruptcy or foreclosure proceedings have occurred. On the other hand, a bridge loan often involves a borrower with excellent credit and income, but does not yet qualify for traditional financing.
Structure of a Hard Money Loan Purchase
Hard money mortgages are most often made by private investors, generally in their local areas. Private investors usually do not rely on the credit score of the borrower, as the loan is secured by the value of the collateral property. Typically, a maximum loan to value ratio is 65-70%. The 30% cushion provides the security for the investor, in case the loan does not get repaid and the investor is required to foreclose on the property.
Below is an example of how a real estate purchase might be structured by a hard money lender:
- 65% Hard money (Conforming loan)
- 20% Borrower equity (cash or additional collateralized real estate)1
- 15% Seller carry-back loan or other subordinated loan
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