What Exactly is a Bridge Loan?
Bridge loans are a form of short-term financing offered by lenders to temporarily fill a capital need in anticipation of a more permanent financing solution. Like any other loan, it is offered as a fixed dollar amount with an interest rate and a fixed term. Interest rates on bridge loans are typically higher than long-term loans as are loan origination and other fees. The loan term is usually structured to coincide with the timing of the new capital infusion, such as the closing of a long-term loan or receipt of an equity investment. Loan terms can range from one month to two years, sometimes longer for certain situations. Once the new capital is available, the bridge loan is paid off.
The turnaround time on bridge loan applications is usually much quicker than a conventional loan. Some lenders have their own source of capital to loan, while others might utilize capital sources from other investors or banks. That difference can determine how quickly a bridge loan can be approved.
Business Uses for Bridge Loans
No business is immune from capital shortages, which is often their biggest impediment to getting to the next level. Businesses that apply for long-term financing sometimes find themselves waiting months for approval and funding. Companies on the fast track are especially susceptible to cash shortages, often outgrowing their cash flow during an expansion phase. Startup companies waiting on an initial public offering (IPO) often burn through their investors’ money trying to build their market valuation. Or, it can simply be a business that experiences extreme seasonal changes in cash flow. The need for a temporary infusion of capital can arise at any time, for any business and for any number of reasons.
The most important factors considered by lenders in approving a bridge loan are the company’s cash flow position and its plan for repaying the loan. In most cases a loan can be approved within seven to 10 days. Lenders that promote a faster turnaround time generally charge much higher interest rates.
Bridge Loans for Real Estate
Bridge loans are especially popular in real estate for investors and homebuyers. Investors use bridge loans to acquire properties they intend to develop or modify to maximize their market value. The bridge loan buys them time to do renovations and lease up the property. They may need a bridge loan for just a few months in the case of quick flip, or a couple of years in the case of a major renovation on a large commercial property. Developers often use bridge loans when long-term financing is held up by permit delays or environmental issues. One of the more common uses of a bridge loan for businesses is to cover the gap between an existing mortgage that is coming due and a new mortgage that won’t be finalized for a period of time.
Homebuyers use bridge loans when they want to buy another home before their existing home sells, but their down payment is tied up in the equity of their existing home. A bridge loan is often their only option because most lenders won’t approve a home equity loan if the home is listed for sale. The bridge loan is secured to the existing home and the funds can be used for a down payment on the new home.
Although the homebuyer will have to qualify for a home loan on the new house based on two mortgage payments, lenders usually exclude the bridge loan payments in their underwriting. Most bridge loans don’t require payments for up to four months, though interest still accrues on the loan.
A bridge loan can be a fast and convenient way for homebuyers to make an offer on a great deal, but all costs should be considered to determine if it makes sense. In addition to a higher interest rate, bridge loans come with a lot of fees for loan origination, administration, appraisal, escrow, and title insurance, which can add up to several thousand dollars.
Bridge Loan Advantages
When used for any purpose, bridge loans offer several advantages, including:
• Provides the borrower with more flexibility and control in situations where time is of the essence
• Buys time for borrowers to maximize opportunities while waiting for permanent financing
• Easier to qualify for than conventional loans
• Can be obtained quickly
• Loans can be tailored to the specific needs of the borrower
The only significant disadvantage of bridge loans is their cost, which should be considered and weighed against their advantages and other financing options if available. In many cases, a bridge loan may be the only option available to meet an immediate need, for which a business or individual would be willing to pay a higher cost. The fact that bridge loans are designed as a short-term financing solution makes it easier to contend with their higher costs.