Florida housing markets are off the charts in terms of investment opportunities. There are incredible properties with gorgeous vistas and coastal charm that buyers are waiting to get their hands on.
Before property investors and real estate businesses can complete the purchase, they need financing. Bridge loans are quickly becoming one of the most popular types of gap financing for this purpose. How can bridge loans help and how do they work?
What Is Gap Financing?
As the name suggests, gap funding refers to financing options that bridge a temporary gap in working capital. It’s a short-term financing method that provides funds quickly and flexibly. Several loan options can fall into this category, including working capital loans and business lines of credit. Bridge loans — also called hard money loans or asset-based financing — are one of the main gap funding options out there.
What Loan Challenges Do Real Estate Businesses and Flippers Face?
The ideal way to buy a property is to apply for a long-term loan with low interest rates. Unfortunately, these traditional mortgages come with a few major drawbacks. They can take a long time to get approved: between several weeks and several months!
Another downside of conventional loans is that they’re not flexible. A loan board has to look carefully at the property you want to buy, give you the OK and determine exactly how much funding will be provided.
For the same reason, it’s nearly impossible to get a traditional loan that covers significant property improvements or remodeling. House flippers that want to purchase a cheap home and turn it into a gorgeous property run into a brick wall with conventional bank loans.
Finally, mortgages only cover a portion of the total purchase price of the property. You always need to have money in savings for a down payment. The amount varies, but it’s common in Florida to need a down payment of 15%–25%. That’s a lot of money for real estate businesses, especially when there are unexpected costs to deal with.
How Can Gap Financing Help With These Challenges?
Bridge loans offer terms that are much more flexible. They let you make decisions quickly and help you maximize the potential of the homes you purchase. Approval for this type of financing is simple, often requiring only basic business information.
House flippers love hard money financing because it adapts completely to project goals. The money you receive is yours to spend however you decide. Did you run across unexpected issues during renovations? You can cover the costs with your bridge loan without needing any special approval.
Gap loans can help you cover purchase costs and remodeling costs. You can get money to hire contractors, subcontractors, electricians, installers and other professionals. You can use funds to buy materials for remodeling.
Even expansion projects and other improvements are on the table. You decide how to use the financing to increase the property’s value the best way possible.
When Are Gap Loans a Smart Idea for Your Real Estate Business?
Gap financing is frequently used in several situations. The way you choose to use it depends on what kind of business goals you have, how many projects you juggle at once and how quickly the current market lets you resell properties.
Bridge loans are a helpful way to supplement available funds. Some real estate businesses have lines of credit that they can use for the majority of the purchase price, but they still need additional capital. If a loan or line of credit has a loan-to-value ratio of 75%, it means the bank only covers 75% of the property’s purchase price. Taking out a bridge loan for gap funding can easily cover the remaining 25% or whatever portion you need assistance with.
Another common situation is when a business wants to buy a property but must wait for approval on a small business loan or mortgage. If the company has been preapproved, there’s a good chance of receiving the loan, but it’s still necessary to wait many weeks or months to know for sure.
What if another buyer swoops in first? With gap financing, the business can get the money to close on the property and then simply transfer the balance to the long-term loan once the financing gets approved.
Real estate businesses and house flippers frequently use gap funding differently. These businesses that have a high volume of home sales can use the profits from completed deals to pay for part of the purchase price for the next acquisition. In that case, it’s easy to use a bridge loan to buy the property right away.
As soon as the previous home sells, the proceeds are used to pay off the bridge loan. This keeps business cash flow and revenue high.
What Are the Advantages of Bridge Loans as Gap Funding?
Gap loans offer pros and cons for real estate businesses. The benefits make them a popular financing tool for many house flippers, property investors and commercial businesses.
Fast Approval and Closing
One incredible difference between bridge loans and traditional loans is their speed of approval. It may only take about a week to get the financing you need to complete a property purchase. That speed makes a huge difference when it comes to real estate.
Sometimes, homes appear at an extremely low price because of bank foreclosures or estate sales. Other times, savvy real estate agents find out about valuable homes before the owners have a chance to put them on the market.
In both cases, having access to a gap loan means you can take advantage of the opportunity. You can make owners an offer they can’t refuse before other buyers have a chance to start a bidding war or snatch a great deal from under your nose.
Stable Business Capital
Real estate businesses and property rehabbers that work on many projects at the same time can benefit from the stability that gap financing offers. In a way, bridge loans are a safety net you can rely on. If you aren’t able to sell a certain property as quickly as you want, you still have money to pay your employees, cover operating expenses, buy remodeling materials and handle other needs.
Working Capital Flexibility
Sometimes, property investors have high net worth but low liquidity. This can especially be the case for property owners who manage a large number of residential and commercial rental properties. The money you make from rent isn’t always enough to cover improvements, remodeling or in-depth repairs. Gap funding can provide an infusion of immediate capital that you can pay off at the end of the month.
With bridge financing, it’s possible to take on deals that wouldn’t have been possible before. Some properties in Florida provide a high return-on-investment once sold but come with a large initial purchase price. Wise investors can make the most of the situation, but first, they need the funds to cover these larger-than-normal deals. Gap funding gives you that extra push to complete high-value purchases.
Accessible Credit Requirements
Not all fix-and-flip businesses are large companies with dozens of employees. A major trend in Florida is for married couples to purchase fixer-uppers and generate profits with remodeling and resale. Normally, banks don’t like to provide loans for this type of deal, especially when individuals are just getting started in the industry.
Bridge loans are different. Your business experience or annual revenue aren’t the main factors for approval. Neither are your credit score or credit history. As long as the value of the property covers the gap funding, taxes, insurance and other costs, getting approved is simple.
What Are the Downsides of Gap Financing for Real Estate?
Like any type of financing, there are times when gap funding isn’t the best choice. It all comes down to your project goals and your business finances.
Compared to long-term loans, gap loans have higher interest rates. That’s why property owners looking for long-term investments only use bridge loans to close on properties until they can transfer the balance to a traditional loan. This technique provides the best of both worlds: fast approval and better interest terms.
Bridge loans just aren’t designed to be used as long-term funding. Most only have terms of six months to a year. This means that commercial remodeling projects that are projected to last a long time may not be the best way to use this funding.
Sometimes, bridge loans have additional fees and costs to consider. These costs are easier to absorb for businesses that handle a large volume of real estate transactions. For a single transaction, the fees may eat into your profits. Costs vary by lender, so it’s good to ask questions before signing the financing agreement.
How Can You Decide If Gap Financing Is Right for You?
As we mentioned before, it’s important to consider your specific business goals when deciding if a bridge loan is the solution you need. Gap funding offers countless benefits, but it also has a few downsides. At HML Solutions, our financial advisors can explain more about bridge financing options. Contact us today for assistance.