Bridge Loan
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So you may have asked yourself, what is a bridge loan also known as a hard money loan? Some homeowners are familiar with a hard money consumer bridge loan, aka “bridge money” in the context of purchasing a home while waiting for their departing residence to sell.
A hard money loan is also known as:
A. What is Bridge Loan?
Bridge loan lenders also known as hard money lenders are typically private investors or investor groups, pools of funds, life insurance companies, and even pension and retirement funds. Hard money loans are an alternative to traditional bank lending that allows flexibility and expediency. Hard money lenders and hard money loans are not required to conform to the same guidelines as traditional financing, such as the standardized Fannie Mae and Freddie Mac underwriting guidelines for loans to be repackaged and sold on Wall Street. Put simply, a hard money loan is a loan that is secured by a “hard” asset – i.e., real property. Because hard money lenders secure their loans with real property as collateral, they are most concerned with a borrower’s equity in the property (or down payment for a purchase). The maximum amount a hard money lender is willing to extend – or leverage – is based on a percentage of the property’s value. Hard money lenders are most concerned about the Loan-to-Value (“LTV”), that is, the loan amount divided by the value of the property.
B. Why Use Bridge Loan?
Every well-equipped borrower’s toolbox should have a reputable hard money funding source. Although banks are usually able to offer lower rates, banks do not offer hard money loans, their loan programs don’t allow for the same flexibility hard money lenders can afford. In addition, traditional lenders have loan committees and a more involved underwriting process, and it is not unusual for both of these to delay the loan process. Hard money loans bridge borrowers from one type of financing to another. Because of this, there are 2 main reasons to use hard money loans:
1) Speed: Same-as-Cash Purchasing Power
One of the main reasons to use hard money loans is their speed. Hard money loans can be closed much quicker than traditional loans, offer in 1-2 weeks, sometimes quicker. Some of the best hard money lenders are able to make their underwriting decisions and issue a term sheet on the first phone call, and some are even able to fund loans in 24 hours! For those needing a quick close with minimal documentation, hard money loans are a great fit.
2) Temporary Financing Needs
Hard money loans are simpler and quicker than traditional loans, and there are two main categories of temporary financing situations in which hard money loans make sense: (1) Property needs to be stabilized; and/or (2) Borrower’s financials need to be stabilized.
(a) Value-Add / Property Stabilization / Fix and Flips / Construction
Hard money loans are particularly well-suited for situations in the financed property needs to undergo some kind of renovation. This can range from cosmetic upgrades to full gut rehabs and rebuilds. The issue for borrowers in these situations is that traditional lenders base their funding decisions on the current value of a property.
Bridge loan lenders also known as hard money lenders, on the other hand, are willing to base their funding decisions (at least in part) on the future value after renovated value (“ARV”) of the property. Hard money lenders are willing to lend on the riskier, future expected revenue of a property, because they mitigate their risk with a lower LTV and charge higher rates.
Fix and flips are a classic situation in which a hard money loan makes financial sense. In these situations, the loan is based on the after-renovated value. Once the property is finished being rehabbed, and realizes its full income-producing capacity (“stabilized”), the hard money loan can be paid off in 1 of 2 ways: sell the property, or refinance with a traditional lender now that the as-is value supports the loan.
(b) Borrower Financials Currently Less Than Perfect
Hard money lenders are far less concerned with credit issues such as foreclosures, bankruptcies, late mortgage payments, etc., and have less stringent underwriting guidelines.
There are times when a borrower is simply unable to provide documental traditional lenders require, whether due to the nature of their business, or the fact that tax returns may not be an accurate reflection of the current financial situation.
Hard money lenders are willing to look past such credit issues where there is enough equity in the property, or a borrower has enough access to capital to make payments on the debt.
Hard money lenders typically do not want tax returns or employment/income info. If there is significant equity remaining in the property after the hard money loan is accounted for, some hard money lenders will refinance a property with nothing more than a Driver’s License, Preliminary Title Report, and a visual inspection of the property (a “drive-by appraisal”).
C. What Does a Bridge Loan Look Like?
Bridge Loan | 3 Options | Typically without an appraisal
1). Valor Bridge Owner Occupied:
Do you need to pull cash out of your primary residence for a business purpose?
- Property being used as the borrower’s primary residence
- Terms of up to 11 months
- Max LTV of 75% on 1st TD | Max CLTV 75% on 2nd TD
- No Prepayment Penalty
*Owner occupied for Arizona, California and Florida Properties ONLY
2). Valor Investment Property | Non owner occupied:
Property being used as the borrower’s investment property.
- Terms 1 to 5 years
- Max LTV of 80%
- No Prepayment Penalty
3). Cross-Collateral Loan:
Do you have a portfolio with properties that have available equity?
- Cross for 100% financing when crossing other real estate owned at 65% CLT for 100% Financing
- Terms of 1-2 years
- Max CLTV of 65%
- No Prepayment Penalty
**no Appraisal Subject to lender discretion on a case by case basis
What is a Fix and Flip Loan?
Fix and Flip loans are hard money loans used to purchase and rehab a property, and then resell it at a higher value. The Fix and Flip lending market has been quite frothy the past few months. If you are an experienced flipper, you may notice that your old lender of choice has increased rates, decreased LTVs, and in some cases quit funding altogether. For first-timers, the market has become substantially hard to break into.
But great news! We have seen a resurgence in fix and flip lending in the past week and are pleased to announce we are funding in 42 states again, and multiple lenders are doing up to 90/100 (90% of the purchase and 100% of rehab).
These loans do not require tax returns, income/employment, or debt-to-income ratio calculations.
Here are some key things to look for when searching for the best mortgage lenders for a Flipper/Rehab:
What is LTC?
Fix and Flip loans are ideal for real estate investors looking to purchase, renovate, and sell a property within a short period of time, usually 12 months. Banks typically will not lend on distressed properties or those in disrepair, which is why private and hard money lenders step in to provide financing.
LTC stands for Loan to Cost, and is a metric used to determine the total loan amount a borrower qualifies for. Fix and flip lenders are currently lending around 80-85% of the total project cost, including the purchase price and rehab budget. Sometimes LTC is expressed as two numbers, for example, 80/100, meaning the borrower qualifies for a loan equal to 80% of the purchase price, and 100% of the rehab funds.
The total loan is constrained by ARV, explained next.
What is ARV?
ARV is After Rehab Value. Lenders are typically between 60% to 70% of your ARV. Meaning if you have a home you purchased to flip and your plan is to sell it for $1,000,000 upon completion, then your max loan amount at 65% ARV is $650,000.
If you find a lender who will give you 80/100 on a flipper loan and you are purchasing the property for $700,000 and doing $100,000 in rehab, then your total loan amount would be $660k + closing costs and fees. $700k * .80 = $560k + $100k rehab = $660k. With the same $1,000,000 sale price, a lender offering 65% ARV will not work, but a lender offering 70% will.
Make sure you account for this when working up your budget and searching for the right lender.
How is interest charged?
Lenders may charge interest on the full loan amount from day one. Alternatively, lenders may charge interest only on funds as disbursed. This can make a substantial difference in the total amount paid back to the lender throughout the life of the loan. Once again, make sure you account for this when writing up your budget.
How do reimbursement draws work?
Most lenders do a reimbursement draw. This means the lender will reimburse renovation costs after the work has been completed. For example, if you pay your contractor $10,000 to complete a new kitchen, you bring the receipts to the lender and they will approve the work done and then reimburse you for those costs. There are some lenders who will advance the money to you, but this is not typical. Many times, if lenders will advance you the money it is going to be based on your track record and the number of projects done.
You also want to keep in mind what the lender’s draw fees are. It is often a good practice to keep your draws to a maximum of 4 to 5 per project to avoid paying a lot of extra money in draw fees.
What is your experience level?
Project experience is the key factor in the rate and terms a lender will provide. When flipping a house, your experience is going to far outweigh your credit and most other determining factors for a loan.
All lenders are going to vary when it comes to how much experience you need for their top-tier programs. With at least one flip under your belt at or around the same value as your current project, you can usually see a substantial jump in LTV and rehab amounts that the lender will provide. Some lenders will consider you as top tier with 5 flips in two to three years and some require as many as 20 in two to three years to reach the top tier. Getting to a lender’s top tier will typically allow you to put less money down, have better interest rates, and potentially lower the origination costs of the loan. Each lender’s tiers are different, so make sure you know where you fit in their guidelines.
How long do they take to close?
The Fix and Flip market is competitive, and therefore a quick close is imperative. In many cases, you will want to have a fast easy close to beat out the competition. I have seen lenders close a flipper loan in 3-5 days and I have seen them close in 3+ weeks. Having a lender that can perform in a quick and efficient manner can make a huge difference in getting the properties you want.
Final Note
Fix and Flip loans are a powerful tool for real estate investors. They are quick and flexible, providing same-as-cash purchasing power. Fix and Flip loans are also the most viable option for financing renovations or other value add projects. If you would like to discuss our new valor hard money mortgage loans give us call today!
1) Types of Hard Money Loans
(a) Fix-n-Flips, Commercial Value Adds, and Construction Loans
Fix and flips, value adds, and other distressed properties, as well as construction loans, can be difficult to finance using traditional lenders such as banks because these types of properties are inherently risky. This is a prime example of where hard money loans can be used.
Construction projects are by nature short-term, and usually, these types of hard money loans are for terms of 18-36 months. Hard money construction loans are used to cover the cost of labor and materials for the development project, and sometimes also the land acquisition.
(b) 1-4 Unit Residential Purchase and Cash Out Hard Money Loans
Hard money loans are commonly used to purchase 1-4 united residential properties quickly because their speed often provides same-as-cash purchasing power.
In addition, many investors utilize the equity in their property by “cashing out,” or placing a lien on property in exchange for cash proceeds.
(c) Commercial Hard Money Loans
Hard money loans are also used for multi-family apartments, commercial, industrial, retail, raw law, and many other property types.
2) Typical Hard Money Loan Terms
(a) Terms
Hard money loans have terms of between 12-36 months but can be longer on a case-by-case basis. They are most often structured with interest-only payments, such that the loan balance is never paid down during the life of the loan, but rather includes a balloon note for the entire loan balance at the end of the loan term.
(b) Rates
Rates and fees charged by hard money lenders are almost always higher than traditional loans. For example, rates are generally between 7% and 12% but vary widely based on property type and use, location, and LTV.
View More Refinance Rates
(c) Fees
Fees charged on hard money loans will generally include 2-4 origination points. Origination points are a percentage of a given loan amount. 1 origination points equals 1%, and for a $500,000 loan 1 origination point equals $5,000. Like traditional loans, hard money loans will also include processing, underwriting, and legal fees, along with all third-party costs such as title, escrow, appraisal, etc.
(d) Loan-to-Value (LTV)
Because the lending decision is based primarily on the asset, the LTV (Loan to Value) is one of the most important ways hard money lenders secure loan repayment. For a purchase, borrowers typically need a minimum of 20% down, and for a refinance they generally must retain at least 20-25% equity in the property.
(e) Property Valuation
Once a term sheet is issued, the next step is property valuation. Value is generally determined through a broker price opinion (BPO) or an independent appraisal. Sometimes if the LTV is low enough, around 50-60% or less, a hard money lender will do a “drive by” appraisal, to confirm the property is substantially sound and in good repair consistent with the lenders internal valuation system.
(f) Exit Strategy
Because most hard money loans consist of interest-only payments in which the principal balance is not paid down during the life of the loan, there is a significant repayment at the end of the term. But this is never cause for concern because savvy investors and the best hard money lenders require a clear exit strategy before funding a hard money loan.
Takeout loans are the permanent financing secured to replace the current bridge loan. This is one of the main ways the balloon payment at the end of a bridge loan is paid.
Another main way to exit a hard money loan is to sell the property. This is often a fix n flipper’s strategy—purchase and rehab a distressed property with financed funds, then sell the renovated property at a profit. A flipper could, however, choose instead to hold the renovated property as a rental, in which case a permanent takeout loan would need to be secured. Once the property is turn-key ready with renters lined up, a traditional lender will be more willing to finance the property.
D. Bridge Loan Myths Debunked
1) 100% Financing—The Holy Grail
FALSE! No Bridge Loan (hard money) lender will provide 100% financing. In fact, many Bridge Loan lenders will require a higher down payment than traditional lending sources. Otherwise, there would be no equity available to mitigate the risks associated with default.
2) Bridge Loans Are Designed to Fail
FALSE! Hard money lenders are looking for a return on their money. In the event of default, they lose out on interest, the ability to place the money elsewhere, and time and effort to foreclose, all of which delay return on investment. Hard money lenders do not want to foreclose.
E. Finding the Best Bridge Loan Lenders
Many hard money lenders also known as bridge loan lenders do not have a retail channel, meaning they will only funds loans procured through a broker. The best brokers spend many hours scouring thousands of loan programs to find the best rate and terms for their clients. Mortgages are largely fungible, and borrowers tend to be rate sensitive, so it is in the broker’s best interest to find the lowest rate and most favorable terms available in order to close the deal. Also, watch out for excessive upfront fees. Reputable brokers do not charge their fees unless and until the loan is funded (although in some instances a lender will require an application fee/deposit). Except for situations in which you are paying for a credit check, appraisal, or placing the funds into a separate performance escrow with a trusted escrow company, high upfront fees and costs can be a potential red flag.
F. Advantages and Disadvantages of Bridge Loans
1) Pros of Bridge Loans
- Speed – Streamlined Process – Faster than traditional loans
- Flexible temporary financing solutions
- Viable option to finance rehab and value add projects
- Less focused on credit history
- Minimal documentation and asset verification
- Interest-Only Payments available
2) Cons of Bridge Loans
- Larger down payment may be required
- Generally, more expensive than traditional loans
- Balloon payment requires good take out strategy (this is not a con for savvy investors!)
G. Hard Money Not A Good Fit? – How To Avoid Hard Money
For borrowers that fall outside traditional underwriting guidelines but are looking for long-term loans with more attractive rates than hard money loans, a great option is no tax return investment property loans. These loans do not require tax returns, income/employment, or debt-to-income ratio calculations. These are a great option for properties that have positive cash flow. They provide the flexibility and lessened documentation of hard money loans, but with rates closer to traditional financing.
H. The Bottom Line
A Bridge Loan also known as a Hard money loan is a powerful tool for real estate investors. They are quick and flexible, providing same-as-cash purchasing power. Hard money loans are also the most viable option for financing renovations or other value add projects. Valor Lending Group is fully licensed in Arizona, California and Florida which makes us able to assist with ALL occupancy types in those states, as well as funding non-owner occupied investment loans in 42 states that don’t require us to obtain their state license to conduct business. If you would like to discuss your hard money options, please give us a call today.
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