When looking to arrange bridge financing, at least part of the borrowing decision is going to be about the cost of capital versus the benefit you are going to get for putting a bridge loan in place.
To properly understand the cost//benefit relationship of any particular deal, you have to be able to accurately estimate the potential cost of capital prior to entering into a short term financing agreement.
Failing to do this may result in a higher cost than the value of the expected benefit, which in hindsight may have caused you not to acquire a bridge loan in the first place.
Depending on the specific lender providing short term or bridge financing, there can be a number of different cost elements to add into the projected cost of capital with some being more material than others.
For instance, there can be a different fee and cost structures from one institutional lender to the next and one private lender to the next.
This can also vary for business loans versus personal loans.
And yes, we are talking about projected cost of capital due to the fact that the effective cost of financing will vary depending on what transpires during the life of the loan.
Let’s break the costs down into fixed and variable components.
The potential fixed costs for the transaction can include legal fees, appraisal fees, environmental assessment fees, lender fees, and broker fees.
All these costs can be accurately estimated before any money is actually spent, but there can be some variability between what is estimated and the final cost paid.
For instance, legal fees can be quoted for the completion of a transaction or by time. Environmental assessments can require additional work which can lead to additional costs. Lender and broker fees are usually a percentage of the money borrowed, so if the amount of money to be borrowed goes up or down, these amounts will change as well.
The variable costs would potentially be things like transaction costs and prepayment penalties.
A lender will typically provide a list of service charges for different events such as NSF payment fees, partial discharges of security, and so on.
Prepayment penalties will be clearly spelled out, but will only be incurred in the event of prepayment prior to the completion of the loan term.
If you expect to repay the loan, or will need to repay the loan prior to the end of the term, then the prepayment penalty becomes a fixed cost.
Most bridge loans are for a period of one year, especially if they are backed by real estate security.
If you assume the worst case scenario and project that most potential costs are going to be incurred including prepayment penalties, then you would divide your total costs by the amount borrowed to arrive at an effective interest rate expressed as a percentage of funds borrowed.
But as I mentioned at the outset of this article, the cost of capital in dollars is the most important thing to understand so that you can determine if the value assigned to the benefits of acquiring short term financing outweigh the costs.
The actual interest rate expressed as a loan interest rate to be charged monthly or the effective rate of financing with all costs factored in is a secondary consideration to the actual projected cost of borrowing.
So once again, determining the worst case scenario and a likely case scenario will be important when evaluating a particular financing option as well as the cost/benefit relationship of the underlying deal.
I'm a Toronto Mortgage Broker that arranges mortgage solutions on residential and commercial real estate property. With over 30 years of mortgage financing experience, I'm able to quickly assess your financing requirements and provide relevant solutions for your immediate consideration. Joe Walsh Google+ YouTube Channel