Hard Money, Bridge Loans, and Amortization

Hard Money, Bridge Loans, and Amortization

You can visit countless websites and find loan calculators based on the amortization principle. Amortization is a common practice for auto loans, mortgages, and other types of non-business funding. Even traditional small business loans are amortized. Is that the case for hard money and bridge loans? Usually, no.

As private lenders, hard money lenders have quite a bit of freedom in how they structure their loans. So amortization isn’t completely off the table. But most hard money lenders do not bother with amortization for either hard money or bridge loans. In nearly every case, a hard money or bridge loan is structured as an interest-only loan in terms of monthly payments.

More About Amortization

Amortization is defined by Investopedia as an accounting technique. It is utilized to gradually reduce the book value of a loan product or intangible asset over a specified amount of time. Where loans are concerned, amortization determines monthly payments and how those payments are applied over the life of the loan.

An amortized loan dedicates a certain amount of each monthly payment toward interest. The rest goes toward principal and, if applicable, escrow. The amortization schedule is set up so that a minimal amount of a monthly payment goes toward principal at the front end of the loan. Most of the payment is dedicated to interest.

As the loan progresses, the tide turns. Principal payments eventually catch up with, and overtake, interest payments. At the back end of the loan, most of the money paid each month goes to principal while very little goes to interest. The point of all of this is to spread payments out for the benefit of the borrower, but still allow the lender to recover interest as quickly as possible.

Payments on Interest-Only Loans

An interest-only loan is not amortized. It is so named because the borrower pays monthly payments toward the interest, points, and fees charged on the loan. As for principle, it is paid in one lump sum at the end of the term. This is the way most hard money and bridge loans are structured.

The advantage to the borrower is lower monthly payments. A real estate investor looking to borrow $350,000 would be happier paying $2500 per month rather than $13,000. Lenders have an advantage in that they collect interest payments first. Since interest represents the lender’s profit, protecting them against default is a good thing. Should the borrower eventually default anyway, the lender can still recover the entire principal amount by seizing and selling collateral.

Short-Term Loans

Hard money lenders generally don’t have any use for amortization for the simple fact that their loans are short-term loans. A typical hard money loan from Actium Partners offers a term of two years or less. Our competitors are generally in the same ballpark. As for bridge loans, 12 months or less is pretty typical.

Even if we wanted to amortize, it would not make sense to do so on such a short-term instrument. The whole point of amortization is to spread payments out over many years in order to make them more comfortable for the borrower. That is not an issue with hard money. Borrowers know they are applying for short-term loans with higher-than-average interest rates. They do not need amortization to make the repayment schedule more comfortable.

Amortization is a great tool for things like mortgages and car loans. It is not very appropriate to hard money and bridge loans. If you are looking for an amortized loan with a repayment term in excess of three years, hard money probably isn’t your best bet.