Sometimes, a hard money loan can serve as a bridge loan if a buyer faces a gap between the purchase of one property and the sale of another property. Typically, lenders will extend bridge loans only to borrowers with excellent credit ratings and when the transactions have a low debt-to-income ratio.
Bridge loans share some similarities with hard money loans. The application, approval and funding process can be faster than traditional sources of financing. But there are some downsides too. These loans may offer the convenience of relatively simple underwriting requirements, but they tend to have short terms, high interest rates and large origination fees. Generally, borrowers accept these drawbacks because they need fast access to the funds.
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So, it depends on the particular situation if a hard money loan is appropriate for a borrower.
“A Matter of Time”
Using a hard money loan as a bridge loan makes sense if the timeframe is right. If a small company is about to be purchased by a larger entity and the sale won't close for six months, then the smaller company might use a bridge loan for capital to cover payroll, rent, utilities and inventory until the transaction is completed.
For example, when Olayan America Corporation planned to purchase the Sony Building at 550 Madison Avenue in New York in May 2016, Olayan took a $570 million bridge loan from ING Capital in order to close the transaction as quickly as possible. The loan helped to cover part of the $1.4 billion cost of purchasing the building until Olayan could secure other sources of permanent long-term funding.
Most of the time, private lenders are the source for hard money.
Given that Olayan America, the U.S. investment subsidiary of the Saudi conglomerate Olayan Group, had connections to wealthy private entities, getting a bridge loan made sense because the transaction's timing was limited. But not every company is as fortunate.
The Type of Collateral Matters
Say a small family business, let's call it Bombshell Bakery for the sake of this example, has enjoyed name recognition for over 80 years. Famous for their “Sweetie” snack cakes and their classic white bread that has been making perfect peanut butter and jelly sandwiches for generations, in recent years the bakery has been facing increasingly stiff competition and rising costs that have gotten to the point where it might be time for the company to retire its products from store shelves and live on only in the fading memories of its former customers.
But the owners don't want to give up that easily. As a result, they've explored selling Bombshell Bakery to a private equity firm, which we'll call Abberline Capital. Abberline has offered a deal that is denominated in cash, equity and stock. Only 15 percent of the total sale proceeds will be in cash. The bakery has just finished paying down debt from an expansion of its main plant over two decades ago, and now that once run-down neighborhood has become some of the most prime real estate in the city. This development puts the bakery in a tough bind.
One possible recourse is to utilize the physical assets of the bakery to secure a hard money loan that can act as a bridge loan until the transaction closes with Abberline. But in this case the equity and debt portions of the deal are subject to a lockup period of six months after the closing. As a result, they cannot be reliably valued and used as collateral for the loan. The physical plant cannot be included in the underwriting because Abberline would not allow any subordinated positions on the plant until after the lockup period has ended.
In this situation, a hard money loan might not be the best solution for Bombshell Bakery because the lockup period seriously curtails the collateral that can be utilized. Another drawback is Abberline’s insistence that the physical plant not be subordinated. Instead, a round of financing based upon the equity and debt might be a better solution, but only if a reliable valuation can be formulated.
Finding the Right Solution
Employing a hard money loan as a bridge loan depends on whether it is the right tool for the job. Not every lending scenario is best served by a hard money loan acting as a short-term financing vehicle. It worked for Olayan America Corporation, but it would not help Bombshell Bakery, given the conditions imposed by Abberline Capital regarding the sale of the company.
A hard money loan and a bridge loan are tools for a particular job.
Much like a hammer is not suitable for every home repair task, the same can be said for a hard money loan and a bridge loan. It depends on the borrowing scenario to determine which one is the appropriate solution.