Investors, whether individuals or businesses, occasionally need temporary financing for a real estate purchase or other large investment. Those seeking short-term financing like this may apply for a bridge loan or bridge financing from a lender.
What Is a Bridge Loan?
A bridge loan is also called gap financing or interim financing. Often utilized when a person or company expects to sell or refinance an asset quickly, bridge loans allow them to continue moving forward while awaiting long-term financing for one reason or another. Individuals or organizations seek bridge loans for a variety of purposes, such as funding a project while awaiting permit approval, avoiding foreclosure, or closing on a property quickly.
Compared to a traditional loan, a bridge loan goes through a faster approval process and can be applied to finances far more quickly. However, it also includes higher interest rates and shorter terms. The loans also demand collateral, such as a real estate property or another type of high-value asset. Borrowers accept the terms of these loans because they need the convenience of fast financing and expect it to be a short-term solution that they can pay off once they receive more permanent financing in the near future.
How Does a Bridge Loan Work?
In order to obtain bridge financing, individuals or companies often use the equity of an existing asset as a down payment when buying a new asset or property. The lender they work with develops a loan that will work best for the investor, based on the type of asset or property they own or plan to purchase. However, a bridge loan often comes with a higher interest rate than other types of financing.
Lenders agree to bridge loans with terms between six and 60 months and prefer to fund borrowers with high credit scores. Oftentimes, a lender will work with the borrower to refinance the loan through a more long-term loan. Generally, interim finance agreements do not impose repayment penalties, given that these types of loans are meant to be paid off in full in a brief amount of time. Lenders expect to close the loans within a matter of months.
How Are Bridge Loans Used in Business?
Bridge loans serve a range of purposes in business. For instance, in real estate, someone looking to acquire a new property while selling another can use bridge financing to combine two mortgages into a single loan until the original property sells. This method benefits a property owner facing foreclosure. It may also attract investors looking to close on a property within a limited time frame.
Real estate most commonly uses bridge loans, but other industries seek interim financing as well. As an example, business or construction investments may be funded through bridge loans while awaiting permit approvals or other compliance or agreement milestones. If a deal requires financing up front, before permitting can be attained, a business may choose to source capital through interim financing. That way, it can cover operational costs, such as payroll and utilities, until long-term financing becomes available.
The appeal of a bridge loan is its promise of quick cash flow during a gap period when an individual or company expects to be cash strapped. However, these borrowers need to secure long-term financing within no more than a few years in order to make good on the terms of the loan.
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