Often in commercial real estate, a buyer needs short-term financing for an investment, repair or upgrade. A bridge loan and a home equity line of credit, also called a HELOC or home equity loan, are good options to secure that financing, but each one can serve a different purpose, depending on your needs.
What’s the Difference Between a Bridge Loan vs HELOC?
Both a bridge loan and home equity loan are meant to be short-term resources for borrowing money. While a bridge loan operates a bit more like a standard loan with a set amount, a home equity loan is a line of credit that allows borrowers to take what they need, up to a certain limit.
What is a Bridge Loan?
A commercial bridge loan is usually used when there’s a need to finance an immediate opportunity. Essentially, as stated in the name of the loan, a bridge loan “bridges” the gap between an immediate need for financing and a longer-term financing plan.
Unlike a standard bank loan, a bridge loan lasts for a short period of time, usually between a few months to a year. To obtain these loans, the real estate you’re purchasing typically serves as collateral on the loan, and the value of the collateral you have to offer becomes a deciding factor in whether you qualify for the loan at all.
Because of the short-term aspect of a bridge loan, interest rates are higher than they would be for a standard loan — generally between 6 to 11%. Bridge loans can be secured from a number of sources, including banks and private lenders.
What is a Home Equity Line of Credit (HELOC)?
A home equity line of credit is a line of credit secured by a person’s property, often their current home. This home equity loan allows a borrower to secure a line of credit using their current home’s equity as collateral for their new home.
Crissinda Ponder at Lending Tree wrote, “A HELOC on a rental property is a type of second mortgage that works like a credit card. Your lender gives you access to a credit line with a set dollar amount, and you draw on that credit line up to the limit as needed.”
The home equity loan lasts for a specific period of time, during which you make interest-only payments. After the period of the home equity loan ends, you then begin making both the principal and interest monthly payments until the debt is repaid.
Can You Use a HELOC to Purchase an Investment Property?
Usually, HELOCs apply to homes, where a borrower takes out a line of credit against their current home to fund home improvements, consolidate debt or purchase a new home. It’s a little bit more difficult to find a lender who will offer a HELOC on investment properties, the reason being that there’s an increased risk when it comes to investment properties.
Corey Chappell, an analyst for 181-Close-Now, an Oklahoma City home financing company, told Leverage.com, “HELOCs are rarely used in commercial real estate simply because the cost of dealing with commercial investments is usually much larger than the amount a HELOC is able to provide.”
The requirements for a HELOC for an investment property are also a bit more strict. Investors might require higher credit scores, a tenant occupying the property for a longer period of time and/or significantly more liquid cash reserves, among other possible conditions.
When Should You Use a Bridge Loan vs HELOC?
With commercial real estate, there are a number of scenarios in which different modes of borrowing work for specific situations. Although HELOCs and bridge loans are both great for short-term financing, there are instances when one makes more sense than the other.
When a HELOC Makes Sense
While HELOCs are less common in commercial real estate, there are a few scenarios in which a HELOC is ideal.
When You Can Make the Purchase With Cash on Hand
Sometimes, a borrower might not know how much money they’ll need upfront, so a loan with a set amount may not be the best option.
Chappell gave an example: “If you’re buying a small apartment complex of 5-10 units and you are able to complete the purchase with cash on hand and intend to use the HELOC for repairs and unexpected expenses, this may be ideal.”
In this scenario, the property owner doesn’t necessarily know how much they’ll need for those repairs, so having a line of credit from your home equity is the best case scenario. However, it’s better if a borrower already has a steady cash flow before seeking out a loan, as HELOCs are not meant to cover all expenses for a commercial property.
HELOCs also make sense if you want to consolidate your debt. HELOCs typically have lower interest rates than other forms of debt. If a buyer doesn’t have an emergency fund, and an emergency situation arises, then a HELOC might be the best way to fund that emergency without racking up the high interest rates of credit card debt.
A HELOC can also help to finance a new purchase using the equity from your existing property, which you intend to sell. If you need just a little bit more cash for a down payment before putting your old property on the market, then a HELOC might be the way to go. In this scenario, you have a line of credit to pay for part of the new property, knowing you’ll be able to pay back that credit in the short-term once you sell your old home.
When a Bridge Loan Makes Sense
For other short-term financing needs, however, a bridge loan often works better, particularly because you can borrow more money than a HELOC typically provides.
When You Have a Need for Speed
Bridge loans allow for instant capital to put a down payment on a new home or property, or to help cover closing costs and origination fees on your mortgage.
Nishank Khanna, the CFO at Clarify Capital, told Leverage.com, “For many borrowers, having access to that kind of cash is essential because it allows them to speed up the home buying process.”
Home equity bridge loans work for those who are confident they can sell their property quickly but want a large chunk of short-term financing that a HELOC can’t provide. This financing is ideal for covering a down payment before the property sells.
In this case, though, a borrower needs to be sure they can make a quick sale and repayment. Otherwise the interest rates from a bridge loan can add up.
When Your Property Isn’t Producing Income Yet
Bridge loans are also useful before you’ve started producing income from your property.
For example, if you’re buying a vacant or REO property that is not yet producing income, you might need a bridge loan.
When the Deal is Riskier
Because of the high interest rates, bridge loan lenders are willing to give money to riskier deals, or for a transitional business plan such as renovations, change in operations or a lease-up.
When a property goes on the market, and you want to make an immediate offer and down payment, a bridge loan works well. With a bridge loan, you can purchase the property right away, which is sometimes necessary in popular neighborhoods with high-demand real estate. After you make the down payment using a bridge loan, you then have time to find and secure a traditional bank loan.
3 Best Practices for Short-Term Financing
With short-term financing, sometimes the risk is greater, so it’s always best to make sure you will be able to pay everything back without accumulating too much interest and debt.
1. Have a Plan for Repayment
Because bridge loans and HELOCs are meant to be short-term borrowing plans, it’s especially important to have a repayment plan in place. Bridge loans accumulate high interest, so taking longer than the loan term to pay back the debt could leave you owing a lot more money than you’d intended.
Before accepting a home equity loan of any kind, make sure you can afford the monthly payments. Successful repayment of a bridge loan will also serve to boost a borrower’s credit score, which will make other forms of financing easier to secure in the future.
Because you may be using your old home or current house as collateral, failure to repay your debt could result in foreclosure.
2. Come Up With an Emergency Exit Strategy
If a steady cash flow doesn’t happen, then it’s important to have a backup plan to pay off the loan. Assets America advises, “Typical exit strategies … include sale of the property, refinancing, or cash payoff.”
3. Have a Clear Plan for Where the Money is Going
It’s important to know exactly how your borrowed money will be spent and how that plan will pave the way for a steady cash flow. If you’re new to short-term financing, it could be beneficial to talk to a financial advisor to make sure the money is being spent in a productive way.
Bridge Loans and HELOCs can be Effective Ways to Finance Your Commercial Real Estate Investment
If you’re looking for a short-term loan on an investment, a bridge loan or HELOC could be the way to go. It’s important, though, to understand which form of financing works best for you and your deal, and to make sure you have a plan in place to pay back that debt.