Hard money loans are a popular option for investors who cannot obtain real estate development finance from traditional lenders but still want to get their hands on some cash. Since numerous business models exist in the real estate industry, there isn’t a “one size fits all” loan type. If you need a hard money lender, there are several different types that you could consider. Today, we’ll be focusing on bridge loans and gap loans. While these options share some similarities as hard money loans, they have some significant differences, and each comes with a distinct set of benefits.
Table of Contents
- » What is a Bridge Loan?
- » How Do Bridge Loans Work?
- » When Should a Bridge Loan be Used?
- » What is a Gap Loan?
- » How Do Gap Loans Work?
- » When Should You Use Gap Funding?
- » Bridge Loan Vs. Gap Loan: Are There Any Alternatives?
- » Looking For A Hard Lending Partner To Help Finance Your Real Estate Opportunity?
What is a Bridge Loan?
A bridge loan (also known as a swing loan) is a form of short-term financing used to bridge the gap between short-term liquidity requirements and long-term loans. These loans serve as a source of funding and capital until you secure permanent financing or remove an existing debt obligation.
How Do Bridge Loans Work?
For the most part, bridge loans work like any other mortgage. The hard money lender qualifies you based on a review of your income, credit, and assets and requires an appraisal to confirm your home’s value.
These are the four main ways that hard money lenders package bridge loans:
1. Closed Bridging Loan
A closed bridging loan means the repayment period is predetermined by both parties. Closed bridging loans attract lower interest rates than open bridging loans.
2. Open Bridging Loan
Open bridge loans usually have no fixed payoff date. Since the borrower can repay the loan anytime, open bridge loans often attract higher interest rates.
3. First Charge Bridging Loan
A first charge bridging loan gives the lender a first charge over the property. If the borrower defaults, the first charge bridge loan lender will receive their money before other lenders. The loan interest rate is relatively fair due to its low underwriting risk.
4. Second Charge Bridging Loan
Here, the second charge lender gets their payment after clearing the first charge lender. Second-charge bridging loans are only issued for a shorter period and attract higher interest rates.
When Should a Bridge Loan be Used?
Bridge loans are most commonly used to eliminate a cash crunch and to “bridge the gap” while buying and selling a home simultaneously.
Of course, the best situation is to have your house under contract and then use the proceeds from that sale to purchase your new home. But circumstances aren’t always perfect. Sometimes you want to buy a new home before you sell, which means you don’t have the funds from the sale to apply to your new home’s down payment. This can be a tough spot to find yourself in if you depend on that money to purchase your new home. In this case, you can take a bridge loan against your current home to cover the down payment on your new home.
A bridge loan might also make sense if you’re a fix-and-flip investor. Since house flipping loans are short-term, you can repay the loan when renovations are complete if everything goes according to plan.
Also Read: Is A Bridge Loan The Right Fit For You?
What is a Gap Loan?
When you apply for a hard money loan, there’s often a gap between what the lender can do and the equity you can provide. Gap loans fulfill the “gap” between your current funds and the needed amount.
Unlike a bridge loan, which is in the first lien position and serves as the primary financing vehicle for a borrower, gap loans are specifically designed for secondary borrowing.
How Do Gap Loans Work?
So, how does gap funding work?
If you’ve been looking around for hard money lenders to finance your fix-and-flip or commercial properties, you might have realized that most hard money lenders aren’t willing to cover the entire purchase and rehab cost. Most lenders, for example, only lend a percentage of the purchase price or after-repair-value (ARV) not exceeding 70% of the home’s value. Does your project have a finance gap? Here is where gap financing comes into play.
In addition to covering the difference between the primary hard money loan and the remaining expenses, gap funding may help you cover rehabbing and marketing costs when selling the property.
Remember that gap loans typically attract higher rates than their loans in the primary lien position. Since gap loans are technically second-position loans, they’ll compensate for the added risk with higher rates.
When Should You Use Gap Funding?
Gap loans are incredibly flexible. You can use them for many purposes, including:
- When there isn’t enough cash on hand to close a deal
- To keep enough money on hand in case another deal presents itself
- To complete any unfinished construction projects on the subject property
Since gap loans are specifically for secondary liens, you shouldn’t look for a gap loan if you don’t currently have financing.
Bridge Loan Vs. Gap Loan: Are There Any Alternatives?
Since bridge and gap loans are expensive and difficult to qualify for, they might not be the right choice for everyone. Consider these three alternatives to gap financing:
» Home Equity Loans
Home equity loans are one-time installment loans that allow borrowers to use their home’s equity as collateral.
» Home Equity Line of Credit (HELOC)
HELOC loans work much like credit cards. They allow you to borrow up to your approved credit line.
» A Cash-Out Refinance Loan
Cash-out refinancing is when you take out a loan worth more than your original mortgage. You’ll repay the original mortgage and do as you please with the remaining amount.
Looking For A Hard Lending Partner To Help Finance Your Real Estate Opportunity?
If a gap or bridge loan sounds like the solution to your investment capital needs, then it’s time to call RTI Bridge Loans at 562-857-2285. Get in touch with our hard money specialists to learn all you need to know about getting alternative financing. RTI Bridge Loans funds hard money loans in California. Fill out their online form for more information.