Understanding your real estate financing options is an essential part to any real estate investment strategy.
Apart from a traditional mortgage, you can also choose between asset-based loans such as bridge loans and hard money loans, especially when you need financing fast. However, it’s a good idea to understand the differences between these financing solutions before signing on any dotted lines.
Bridge Loan vs. Hard Money Loan: Overview
Bridge loans and hard money loans are categorized as asset-based loans. An asset-based loan is defined as lending money in an agreement that is secured by collateral. Examples of collateral include real estate, inventory, and equipment. In this article, we will be focused on loans secured by real estate collateral.
Both bridge loans and hard money loans offer short-term financing ranging from 12-36 months and are typically interest-only loans. An interest-only loan means that your monthly mortgage payment will only cover interest, and the principal balance will be due as a lump sum when the loan reaches maturity.
While both loan types serve similar purposes for real estate investors, key differences between a bridge lender and a hard money lender revolves around how they manage their appetite for risk.
Let’s explore the differences and similarities between a bridge loan and hard money loan in more detail:
What Is a Bridge Loan?
A bridge loan is an asset-based loan that is meant to be a temporary financing solution to “bridge the gap” between right now and a short time in the future. This is an ideal solution for real estate investors who have funds tied up in other investments and do not want to let a good real estate investment opportunity pass them by.
For example, let’s say you are in the process of selling your investment property and plan to use the sale proceeds to purchase a new investment property that is time sensitive. Unfortunately, you experience a delay in the sale of your existing property and do not have the cash to close on your new purchase.
Instead of walking away from a great investment opportunity, you can use a bridge loan to fund the deal as fast as if you were paying all cash. In this way, bridge loans offer additional flexibility for investors and allow them to make quick purchases or sales when they are experiencing a sudden gap in liquidity.
Bridge loans can also provide you with the money you need to execute on a deal quickly while you wait for long-term financing to fall into place, which can normally take a few months of more, depending on your approval requirements.
Benefits of Bridge Loans
Bridge loans are flexible by nature, and can be structured to fit your specific investment needs. They can be used for purchasing or refinancing a residential, commercial, or vacant land for investment purposes and for bridging the gap in liquidity while you wait for long-term financing or a pay out from a sale of an asset or other investment.
Like most asset-based lenders, a bridge lender will primarily focus on the collateral value when making a lending decision. This means that you won’t need to provide proof of income like tax returns or paystubs to get approved. However, some bridge lenders can offer a higher loan-to-value or a lower interest rate by including the sponsor’s financial strength, background, creditworthiness and real estate experience in their risk analysis.
Additionally, bridge lenders often offer higher loan amounts and specialize in financing luxury investment properties like pre-construction condos and waterfront land for development. This makes a bridge loan a viable option for investments in the multi-million-dollar range.
Drawbacks of Bridge Loans
However, bridge loans do not work for every real estate investment strategy. For example, most bridge lenders will prefer to lend on completed assets or lend against the current value of the asset. This means that securing a bridge loan to buy a fixer upper that requires significant renovations may be difficult, or will require you to borrower less since the lender will lend on the current value of the property instead of the after-repair value, or ARV.
Keep in mind that while a bridge loan is not ideal for fix-and-flip scenarios, it can be used to purchase and refinance land. This is a good option for spec home developers and custom home builders who want to purchase land or tap into the equity of the land they currently own to start the construction process while they wait to get approved for a construction loan.
What Is a Hard Money Loan?
A hard money loan is a loan collateralized by a “hard” asset, such as real estate, equipment for a business, inventory, or a vehicle. In real estate, a hard money loan is secured by the value of the collateral, which can be a residential or commercial asset.
A hard money lender will focus solely on the value of the asset when structuring loan terms. This allows them to fund deals quickly since they require little to no documentation on the sponsor’s financial strength or creditworthiness. This makes hard money loans a good option for borrowers with bad credit or unverifiable income.
If you own an investment property that requires significant renovations before you can lease it, you can use the property as collateral to secure a hard money loan. The cash proceeds of the loan can then be used to finish renovations.
Benefits of Hard Money Loans
Hard money loans have several benefits and advantages. For starters, they require little to no documentation and you can get approved even with bad credit.
Additionally, hard money loans are quick to approve as they only focus on the quality of the asset. If an investor needs money fast, a hard money loan could be the way. Another reason is that some hard money loans can offer 100% financing through cross-collateralization.
This makes a hard money loan a good option for investors that want to tap into the equity of their portfolio to purchase more properties. The easier approval also makes it more accessible for new investors who want to break into the fix-and-flip market.
Drawbacks of Hard Money Loans
That all said, hard money loans do have some potential downsides. Firstly, because they do not factor in creditworthiness or financial strength of the borrower, they usually have higher fees and interest rates than traditional loans or alternative means of financing in order to compensate for unknown risks.
Some hard money loans can also come with pre-payment penalties if you decide to pay off your loan early. The pre-payment penalty can be a percentage of the loan balance or a lump sum. If paying off early is an option you want to consider, make sure to ask your lender upfront what fees are associated with an early pay off.
Similarities Between Bridge Loans and Hard Money Loans
Higher-Interest Rates (compared to traditional loans)
Higher-Interest Rates (compared to traditional loans)
Bridge loans and hard money loans have several similarities to keep in mind. Firstly, they both usually have higher interest rates than a traditional loan because there is little to no income verification involved and the lender is taking on more risk.
In terms of rate type, asset-based lenders often offer both variable and fixed rate options. They are also interest-only which means your monthly payment will only cover interest. As an investor, this can help keep your monthly expenses low while you are awaiting a sale of another asset or to wrap up on renovations.
Both hard money and bridge loans also offer fast financing to investors. Hard money loans don't care about your credit score or liquidity; they just care about whether you have collateral to provide as an asset-based guarantee.
Bridge loans are also usually quickly approved if you qualify, as they're typically needed very rapidly by borrowers who apply.
Bridge loans and hard money loans can further offer monetary flexibility to borrowers. You can use these for real estate investments and purchases, paying off loans, and bridging the gap between loans.
Lastly, hard money and bridge loans are short-term financing solutions. Due to their high-interest rates, you should never plan on keeping these loans outstanding for too long. Make sure to have a plan in place on how to repay the loan, also known as an exit strategy. Common exit strategies for an asset-based loan include:
Refinance the loan
Sale of the asset
Payout from other source/investment
The Bottom Line: Which Is Best for You?
Ultimately, neither option is better than the other, it all depends on the asset, your financial situation, and your overall investment strategy.
At Vaster, our knowledgeable and experienced loan officers can walk you through your options and see if our asset-based portfolio lending program is right for you. Our approach to lending is centered around being transparent about our rates and fees so borrowers feel confident about securing a loan with us.
Contact Vaster today to learn more about our financing solutions and get approved in as little as 24 hours.