What is the difference between a bridge loan and a construction loan?

In the real estate investment community, the terms bridge loan and construction loan are used often referring to the same type of loan.  This article will explain the differences.   

According to Investopedia a bridge loan is a short-term loan used until a person or company secures permanent financing or removes an existing obligation. It allows the user to meet current obligations by providing immediate cash flow. Bridge loans are short term, up to one year, have relatively high interest rates, and are usually backed by some form of collateral, such as real estate.  These types of loans are also called bridge financing. 

A construction or rehab loan is a type of bridge loan with construction funds available for future draws dependent on progress of the project.   A simple way to distinguish a construction loan is this loan is funded at the initial closing and then in draws during the construction phase of the project depending on progress.  A bridge loan is funded one time and typically does not include future construction draws.

Investors request bridge loans for various reasons such as:  

• To meet a closing deadline

• To appease a seller

• Rezoning a property

• Soft costs (design, engineering, site work) 

• Hard construction costs

• Residential Flip

Here are some benefits for using a bridge loan in your business:

• Prompt underwriting. Typically, the hard money lender is also the one approving the loan.

• Lender may not require an appraisal.  Appraisals typically take 2-3 weeks.  Some hard money lenders do their own valuations or order a BPO (Broker Price Opinion) with a short turnaround time.  Also, hard money lenders evaluate the current value and the ARV (after repaired value).

• You could be considered a cash buyer.  You should use a hard money lender willing to discuss a deal before you lock it up under contract.  They can provide a proof of funds letter to make your offer stronger than the competition.

• Wholesale deals for a higher profit than assigning the contract.  Occasionally, it makes sense to close on a property that has a high profit margin versus assigning the contract at the closing.  This scenario is worth paying short term loan fees to resell quickly.

• Higher profit margin than having a financial partner.  The typical partnership is a silent partner providing the funding the active partner managing the acquisition, project, and backend transaction.  The typical profit sharing is a 50/50 split.  Why pay 50% with the ease of acquiring a bridge loan? 

So how do construction draws work with hard money loans?

After the purchase, at certain stages of construction the borrower will request a draw from the lender to reimburse them for costs incurred.  At that time, the lender will either perform a visual inspection themselves or hire an inspector to view the progress of the project.  Alternatively, the lender may require photos, invoices and receipts of paid materials and labor.  These inspections are matched against the construction budget to figure the percentage complete of the project.  It is then determined the amount to advance to the borrower based on the budget.  Funds are released to the borrower via wire or check to the borrower and the loan amount is increased.  The borrower can choose to fund part of the construction with cash on hand to save on increased interest of the loan.

Bridge loans are used in all types and loan amounts in real estate ranging from a small residential rehab or rental up to large commercial projects.  Remember a bridge loan could be a good tool when evaluating your next deal.