Hard money commercial loans: Hard, Bridge, Rehab – what’s the difference?

Knowing the difference between rehab, bridge loans and hard money loans can better help you achieve your needs.

Hard money commercial loans can be confusing enough but when  a borrower first steps out and  is introduced to terms such as rehab and bridge the field becomes even  more perplexing. Telling you some of this history and sorting the differences between terms may hopefully smooth the route.

Hard Money

Fittingly, the hard money industry first appeared during the Depression. According to the FDIC Office of Inspector General (2003), banks collapsed and closed under their load so  private individuals took advantage of the miserable situation and used their own funds to invest in individuals. The enterprise expanded in the 1950s and soon sprung unscrupulous lenders who took advantage of misinformed borrowers, and so the term ‘shark industry’ was born.  The industry suffered severe setbacks during the real estate crashes of the early 1980s and early 1990s due to lenders overestimating and funding properties at well over market value. In response, the  market reduced its LTV rates and doubled its interest expectations as means to protect itself.

Hard money lenders essentially  lend a loan to anyone who needs it focusing on their collateral rather than  credit rating. Most times, collateral seems to apply to property but rather it could apply to anything that the lender considers valuable. Secondly even though the lender at one time barely reviewed the borrower’s credit, today regulations such as the Dodd Frank act are forcing  lenders to become more vigilant and  to review the borrower's credit history and performance too.

The upsides of hard money are several. There is the fast turnover - as little as a week. Sometimes, the borrower receives the money in two or three days or even the same day.

On the other hand, there is the low LTV rate and higher interest rates, usually double to triple that of the regular mortgage.This low LTV (loan to value) and higher repayments provides added security for the lender  in case the borrower does not pay and the lender has to foreclose on the property.

Hard money commercial loans are wonderful for some individuals who need a loan in a hurry such as for quick turn around or after repair situations. Others  are advised to seriously review their finances and reconsider before entering this.

Bridge Loans

Bridge loans are similar and different. Bhutta, Skiba and Tobachman in their 2015 journal article “payday loan choices and consequences” (Journal of Money, Credit and Banking) say that the primary differences are that a bridge loan often refers to a commercial property or investment property that may be in transition and does not yet qualify for traditional financing. Hard money, on the other hand, often refers to not only an asset-based loan with a high interest rate, but possibly a distressed financial situation, such as arrears on the existing mortgage, or where bankruptcy and foreclosure proceedings are occurring. These loans are called ‘bridge’ loans  (or ‘caveat’ or ‘swing’ loans) because they span a transition period between when the borrower need the loan and when he buys the property. Bridge loans are exclusively meant for mortgage purposes and are usually short term - a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing. It is an interim sort of financing until a more permanent sort of loan can be found. So if you needed fast money for  renovation and were then intending to approach the bank for the rest, you may consider approaching a private lender for a bridge loan. The subsequent money would be called the ‘take out’ loan because it would be used to repay this ‘bridge loan’.

All aspects of the loan are more expensive than a conventional loan from the points (points are essentially fees, 1 point equals 1% of loan amount) to interest rates to origination costs and the lender would want to see that you have a plan in place for the take over i.e for your permanent financing.

Bridge loans are used in venture capital and other corporate finance for purposes that include the following: They inject small amounts of cash into a company so that it continues to run between successive major private equity financings. Bridge loans maintain air in distressed companies while these companies search for an acquirer or larger investor (in which case the lender often obtains a substantial equity position in connection with the loan). Bridge loans may also serve as a final debt financing to carry the company through the immediate period before an initial public offering or an acquisition.

Finally, bridge loans serve as purpose or rehab loans which are essentially loans for helping an investor  rehabilitate a building in order to sell it. These type of loans are speculative - the  borrower may not succeed in  selling his building after rehabilitation or at least not selling for a profit or for price wanted. For this reason, banks are highly reluctant to dabble in these sort of loans. Private lenders are  naturally wary too which is why they  offer rehab loans - at far higher points, payments and interest roses than banks. After all,they're taking a greater risk.

Rehab Loans

There are various types of rehab loans. All achieve the same results. They help the borrower remodel his property so that he can (hopefully!) sell it for a profit. These FHA 203(k) loans also called renovation loans enable homebuyers and homeowners to finance both the purchase or refinance along with the renovation of a home through a single mortgage. Instead of applying for multiple loans, an FHA 203(k) rehab loan allows homebuyers to purchase or refinance their primary home and renovate it with one convenient loan.  In their history on the differences of loans, Bhutta, Skiba and Tobacman say that purchasing a fixer-upper was once virtually impossible since most banks were reluctant to grant a mortgage to a home that was in disrepair. On the other hand, repairs couldn't be made until the home was purchased. This put home buyers in an untenable situation. Now, these rehab loans allow home buyers to purchase a property and repair it since it includes the cost of repairs and improvements in the loan. This also makes it easier than ever to purchase a fixer-upper or renovate your current home.

These are the things you should consider when applying for a rehab loan:

1. What you paid.  Don't expect the rehab lender to lend hard money based on an as-fixed basis. Rehab loans will almost always be based on as-purchased price sot at private investor funding you protects himself in case you buy the property and do not make the improvements.
2. Upside Potential.  The lender may not use future value as the basis to consider loan to value be he definitely absorbs it in his appraisal in order to evaluate how risky the rehab loan is.
3. Extent of the Rehab. Projects that are riskier and require more substantial work will run up (or rather down) lower loan to values. Hard money is all about risk. The greater the investment, the more the lender seeks to protect himself. A residential property that just needs carpeting is far less riskier than a vacant 35 unit apartment building in which all the units and the main property need a facelift.
4. Personal Financials.  The stronger your personal balance sheet and real estate performance history, the more likely you are to obtain rehab loans.  Rehab lenders want strong borrowers. If the project under consideration is your first one, you will likely want an equity partner to build a track record and help you get started. If you can satisfy the lender with other collateral, including real estate, cash and stocks, you will be much more likely to obtain the loan.
5. Prepay Penalties.  Private investors in rehab loans want to know they will make a return on their funds.  Expect to commit to use the funds for a fixed period of time or pay an additional penalty.

Some investors like to apply for or invest in Rehab loans. if entered into wisely, they may be a great way to earn a high return on real estate.

In short, hard money commercial loans have their variances. Know the differences and you can better achieve your needs.