How do bridging loans work?
You’ve found the perfect property/building. It has the square footage you need, the layout is perfect and the location couldn’t be better. The only problem? You don’t have all the long-term financing in place just yet.
While there are many reasons why this could be the case, it most commonly occurs when the building in question requires significant repairs before it can qualify for a commercial mortgage. Although this can feel like a roadblock, it doesn’t have to be.
As their name implies, commercial bridging loans serve to “bridge the gap” between the purchase of a property and the establishment of permanent financing. When you’re ready to move on a great piece of real estate but are still working out the fine-print details, they can be incredibly valuable resources.
Today, we’re taking a closer look at how bridging loans work and the steps you can take to qualify for one today.
Ready to learn more? Let’s get started!
What are bridging loans?
In short, a bridging loan is a type of flexible loan arrangement.
Its goal is to provide the short-term financing that business owners require to purchase or upgrade a piece of commercial real estate in situations where permanent mortgage financing is not an option. For this reason, you might also see these loans referred to as commercial mortgage bridging loans.
Most bridging loans carry a repayment timeline of between six months and a year, although some can be in place for up to a few years. You can use funding from a commercial bridging loan to cover costs associated with a property you currently own or one you wish to acquire.
Collateral Vs Creditworthiness
A bridging loan is a type of collateralized loan. This means that you’ll prove you’re a trustworthy borrower by putting up some collateral you already own or plan to purchase in the near future.
In turn, most lenders will approve your request based on the value of your collateral, rather than taking a close look at your credit score. This means that a bridging loan is often easier and quicker to obtain than a standard commercial mortgage.
To limit their financial exposure, most lenders will cap their bridging loans at 70% to 80% of a property’s anticipated future value. You’ll make up the difference using your own equity. In addition to your collateral, other factors that a lender might analyse to determine whether to issue your loan include:
- The location of the property
- The condition of the property
- Your history of negative financial events (e.g. bankruptcies, liens, foreclosures, felonies)
Examples of common uses
Most often, long-term financing is out of the question for the business owner because the property requires major renovations and uplifts. Yet, this isn’t always the case. A few other reasons for pursuing a commercial bridging loan include:
- When you’re moving a business
- When the borrower’s credit score is sub-par
- When the borrower is pressed for time and cannot wait for long-term financing
Let’s take a look at each of these in greater detail:
Maybe the building you’re eyeing has great bones but needs a major facelift. Or, perhaps the occupancy rates on your current building aren’t where they need to be and a few structural adjustments could make all the difference.
In either case, a bridging loan can finance the necessary upgrades and renovations. When the work is complete, you can replace it with long-term financing.
Short acquisition timelines
Commercial real estate can be a hot commodity. You might have only a few hours to place a bid on a property before a competitor places one higher.
If you don’t have all of your loan details lined up before you take this step, you could lose out. With a bridging loan, you can go ahead and make a substantial down payment on the property. Then, you can use it to make your monthly payments until long-term financing is in place.
Moving a business
Planning to move your e-commerce website to a brick-and-mortar storefront? Moving your entire office into a building across town?
You can apply a bridging loan as the down payment on the purchase of the new property. You can even use it to help pay off any existing mortgages you still have on your old properties.
Low credit scores
It’s no secret that it’s harder to obtain a commercial mortgage if your business’ credit score isn’t strong. Lenders use this score as a gauge of your overall creditworthiness and ability to pay the loan back over time.
This is when it pays to pursue bridging finance. As mentioned, these lenders verify your loan through the collateral you put up, not the number associated with your name. Thus, a low credit score doesn’t minimize your chances of getting the funding you need.
The best part? As you work to make timely payments on your bridging loan, you’ll boost your credit score in the process! In some cases, you can raise it high enough to qualify for long-term financing.
How a bridging loan can work
As you research your options, you’ll find different rates and terms for commercial bridging loans. In addition, every lender will take a look at your specific situation and offer a unique route forward. That said, the basic process for obtaining and paying back a bridging loan is the same across the board.
Say you purchase a new office building for £800,000. It’s small, needs repairs, and is under-occupied. You know that to renovate it and attract more tenants, you’ll need to spend an additional £500,000. That means you’ll need £1.3 million in all.
When all the work is finished, let’s say the building will be worth £2 million.
With this data in hand, you can apply for a bridging loan from a commercial provider. He or she offers to lend you 75% of the total £1.3 million you need, or £975,000. This loan has a term of one year.
That means that you must provide the remaining £325,000.
When the project is finished, you should be approved for a £2 million mortgage on the newly updated property. With those funds in place, you should be able to pay off most of the bridging loan, including the principal and interest. If your interest rate is 10%, your total interest will equal £97,500 plus fees (e.g. origination, prepayment).
Where to find a bridging loan
There are many different institutions that offer commercial bridging loan financing. These include:
- Credit unions
- Peer-to-peer lending platforms
- Private commercial finance companies
- Online hard money lenders
Before partnering with any entity, think long-term. It’s usually best to apply for your bridging loan at the same place you intend to set up a long-term mortgage. Sometimes, this can work in your favour and allow you to obtain a better rate or more flexible loan terms.
When you find the right partner, make sure to do your due diligence before signing on the bottom line. Let’s review three important areas of your contract that require special attention.
Especially if you pursue online funding, you might find that your lender will broker your loan to a wide network of third-party lenders. In turn, the broker will receive what’s known as a finder’s fee. This fee is then woven into your payment structure, normally included as an origination fee.
Most lenders will call these fees “points”. These are initial costs added to the total value of the bridging loan. In some cases, origination fees can be as high as 6% or more. That’s why it pays to compare several options rather than jumping into an agreement with the first lender you find.
Penalties against prepayment
Say you sell your existing property before the term of your bridging loan has collapsed. In this case, you can go ahead and pay it off early, but some lenders won’t make the process easy (or cheap). Many will impose a prepayment penalty equal to a few months’ interest for bowing out of the deal before the designated time.
You need to know about all of these charges ahead of time to avoid any surprises. While you’ll be hard-pressed to find any bridging loan provider that doesn’t enact at least some form of these fees, the key is to comparison shop to find the best deal, terms, and conditions.
Discover the beauty and benefits of bridging loans
A great piece of commercial real estate is worth its weight in gold.
Whether you’re rehabbing your existing spot or setting your sights on a new one, bridging loans can provide the interim financing you need to move forward. In the meantime, you can take the next steps toward making your new space the best it can be.
Are you a business leader looking to learn more about all things commercial real estate? You’ve come to the right spot.
Our team of financial experts is dedicated to helping you compare your options and find the best solution for your needs. Contact us today to learn more and let’s grow together.
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