When it comes to investing in real estate, few tactics bring confusion to mind quite like hard money loans and commercial bridge loans. Not only are both terms often used interchangeably, sometimes incorrectly, but their strengths and weaknesses are also misunderstood. When it comes to financing commercial real estate, let’s settle the difference and explore when to best leverage each loan type for a sweet deal.
Hard Money Loan vs Bridge Loan: What’s the Difference?
Let’s clear a common misconception by stating this fact: not all bridge loans are hard money loans. But all hard money loans are bridge loans, technically — they’re just not called by that name when they’re used.
While there are no hard and fast rules to distinguish between them, you can think of them more as a gradient. The easier and faster the loan is to obtain, the more likely it’s considered a hard money loan. Regardless, both loans put a priority on speedy approval and short loan terms, providing funds for a borrower to improve, fix or flip an asset. That’s right, bridge loans don’t take long to get!
What Is a Bridge Loan?
As its name implies, a bridge loan is a short-term financing option used to bridge the gap between obtaining or improving a real estate asset and securing the next stage of financing, usually a long-term permanent commercial loan with better terms.
According to Gunnar Wilmot, Senior Financing Broker at Lev, a digital-first real estate brokerage, “It’s getting you from A to B. Let’s say you’re buying a five-million-dollar building that’s vacant and in need of repairs. You put in 1 million, get a bridge loan for 4 million, and you renovate every unit, renovate the lobby, and put in a new elevator. If you do all that in a year and the property’s worth 10 million dollars, now you can get a conventional loan at a 10 million dollar value.”
Bridge loans are usually faster to obtain and qualify for, and they rely less on the borrower’s own financials. Instead, the lender relies on their confidence in the asset in question. In exchange, the borrower accepts higher fees and interest rates. On the upside, bridge loans can be flexible as to when interest and fees must be paid. For example, they may defer interest payments until the loan becomes due.
From the lenders’ perspective, the different loan types and terms are due to the changing landscape of risk. The risk profile is vastly different for an empty lot, the construction project, and the final stabilized property, and that’s why you have these different financial products.
When Would You Use a Bridge Loan?
When it comes to commercial real estate, a real estate investor interested in bridge loans would like to acquire a commercial property quickly, remove an obstacle or fulfill an obligation.
In the first case, perhaps the buyer is aware the property in question is a gem with potential upside and wants to be first at the closing table.
In the second case, perhaps an owner’s existing property is in need of major improvements, and occupancy is down. The owner knows that, with the right renovations, their occupancy would improve and the property value along with it. But before they can secure a loan with better terms, it may be in their interest to secure a bridge loan to get them there.
In the third case, the owner is trying to fulfill an obligation and needs to buy themselves time. In one dire circumstance, an owner may use a bridge loan to stave off a commercial short sale or foreclosure. The terms may bind them to high interest rates, but the money gives them time to come up with a plan to improve the property or find a buyer. In the end, they may still lose money but with far fewer long-term repercussions than with foreclosure, which can affect their buying power in the future and put their personal assets at risk.
What Is a Hard Money Loan?
Like all bridge loans, a hard money loan is a short-term loan with fast approval and flexible terms. Among bridge loans, hard money loans are the least scrupulous when it comes to the borrower’s financials or experience. They place the emphasis squarely on the “hard” asset in question. This hard asset used for collateral is always the investment property in question.
However, for some lenders, even this is not enough. If it’s a recourse loan, a borrower will put their personal assets on the line should they default. Whereas some bridge loans can come from institutional sources, a hard money lender is always an individual or private firm, as they don’t abide by the strict regulations that banks must.
When Would You Use a Commercial Hard Money Loan?
Hard money loans are designed for borrowers who aren’t eligible for traditional mortgage loans. As Wilmot put it, “Maybe the borrower has had a recent arrest, a credit score 500 or below, or recent mortgage delinquency. Maybe they’re buying a piece of land that they want to turn into a hotel and they’ve never built or operated a hotel before.”
The hard money loan is there to fill a void that a bank won’t.
As a result, the lender charges the steepest fees due to the potential risks they incur. Hard money lenders are always private, as a rule, and operate outside lending regulations. For these reasons, hard money has a bad reputation, as they can sometimes attract predatory lenders, “loan sharks” who loan-to-own or worse, take the deposit and drop out come closing time. In these cases, be away of scams like wire fraud, unethical kickbacks, and other white-collar crimes.
Nevertheless, there are trustworthy hard money lenders to be found, just as there are opportunities that warrant this type of funding. For example, unless they were wealthy to begin with, most home flippers got their start with a hard money loan until they got some experience under their belt for better loans on their next ventures.
What Do Commercial Bridge Loans and Commercial Hard Money Loans Have in Common?
- Short term
- Fast approval
- High interest rates and fees
- Flexible terms (often)
What Makes Commercial Hard Money Loans Different From Commercial Bridge Loans?
- Always private money lent by a private individual or firm
- Easiest to obtain
- Highest interest rates and fees
- Private money lenders are usually more flexible
4 Questions to Consider When Choosing a Type of Loan
1. Can you do better?
Expensive loans of any kind should never be your first choice if you can help it. According to Uri Pearl, a Financing Expert at Lev, you should always shoot for the stars, starting with your own personal bank. Ask them what they’re looking for in a potential borrower. Assess your personal finances and income for ways to improve. If you don’t try, you’ll never know.
Not all bridge loans are created equal. Your mindset should be for lenders to compete to give you better terms. Before jumping on a hard money loan, Wilmot recommends considering the slower route — improving your credit, getting any criminal record expunged, buying a cheaper property with better terms, and stabilizing it to the point where a bank would do the deal.
2. How sweet is the deal?
Before shopping for a loan, you need a good opportunity in the first place. Appraise the asset’s value, do your due diligence and crunch the numbers. Then you need to feel confident in your plan to improve its value. Only then can you know if the loan terms will keep you in the green.
If you’re eligible for a bridge loan, are you confident in your ability to make the payments? Have they sweetened the deal with interest-only payments or even a lump sum at the end. Are they lending only on the value of the property or are they covering enough for you to pay for improvements?
If you’re only eligible for a hard money loan, are you confident you will turn a profit despite steep interest rates and fees? If it’s a recourse loan, are you willing to part ways with certain personal possessions should things go south? Perhaps you have less than stellar credit, but you’ve found a diamond in the ruff and you want to jump on the opportunity before others come for the gold rush.
3. What do you bring to the table?
If you want the best loan for your investment, two qualities will give you leverage — either good financial standing or previous experience, preferably both. This status will determine if you can qualify for institutional loans with fantastic terms or if you’ll need to go to a private bridge or even hard money lender.
Good financial standing entails some combination of good credit, income, net worth and solid assets such as a property you already own. Should you lack in some of these regards, you may still be eligible for certain bridge loans if you have previous experience. If you can demonstrate your ability to structure and execute similar deals, a lender is likely to grant you better terms.
Without good financial standing or experience, a hard money loan may be the only financing option available. Even then, it’s important to find a trustworthy lender.
Finally, there’s actually a third way: you can partner with others. It’s a topic that deserves its own article, but know that you can always team up with someone who can compensate for a lack of experience or financial standing.
Either way, rest assured that all bridge loans — unlike traditional financing — place more emphasis on the asset you’re looking to buy rather than put the microscope on you.
4. Do you have a sound strategy for the investment property?
When it comes to commercial real estate, a solid business plan is what makes or breaks an investment. It will also persuade lenders into granting better loan terms. The more detail, the better.
Plan for multiple contingencies:
- Does your deal make sense even in the worst-case scenario?
- How do you plan on removing obstacles, lowering operating costs or improving the property?
- When that’s done, how do you plan on attracting more or better tenants?
Best Practices for Securing a Hard Money or Bridge Loan
1. Do Your Homework
Before sourcing the right lender and entering any negotiation, you need to know your stuff.
Pearl said, “You got to know the deal in and out, you want to model it out, what it’s going to produce, how much it’s going to cost, how long it’ll take. You have to know that inside and out before you go to the lender.”
Of course, if you want to go through a broker, it’s their job to arm and assist you through this process. Nevertheless, the more you’re armed with knowledge, the sweeter your deal will be.
2. Interview Potential Lenders
Finding a lender should be no different than comparing deals at several groceries in your neighborhood. If you’ve done your homework, then you know your value, the value of the asset in question, and its potential value. Your goal is to find the lender who will give you the best terms. Furthermore, you should do your due diligence to make sure they’re trustworthy. Pearl says that it’s common practice to ask a lender about deals they have sealed in the past, and asking them for references.
3. Interview References
When the lender gives you a list of references, you should follow up with several to hear about their experience. Was the lender forthcoming, quick to give and process paperwork? Did they follow through on obligations? Did they embed sneaky fees into the fine print? These are crucial questions to avoid a predatory situation and to protect your deposit.
Let’s Not Split Hairs
When it comes to defining hard money versus bridge loans, there are no hard and fast definitions. Ultimately, a different broker, buyer or lender may use each term differently or set different parameters. And while hard money loans may bring visions of the “Wolf of Wall Street”, that’s simply not the full story. After all, there are bad bridge loans and good hard money loans, depending on the circumstance. Nevertheless, we hope this primer got you thinking about getting creative with your financing. If anything, this article shows that when there’s a will, there’s a way.